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Repayment vs interest-only mortgages

There are three types of repayment structures: interest-only, capital repayment and 'part and part' (which is a mix of the two).

Here's how they work:

How does a repayment mortgage work?

With a capital repayment mortgage, your monthly repayments are calculated so you'll have repaid all the debt and the interest over the term you agree (eg, 25 years). It means your monthly payments both cover the interest and chip away at the actual debt, so at the end you owe nowt.

This has a strange effect. In the early years, your outstanding debt is larger so most of your monthly repayments go towards paying the interest. Gradually, as you reduce what you owe, most of your repayments go towards paying off the debt.

For example, on a £150,000, 25-year mortgage at 3%, you'll pay £711 a month. After 10 years you'll have made £85,320 in payments, but only reduced what you owe by £47,000. Yet after a further 10 years, having paid another £85,320, you've reduced the debt by a further £63,420. This is because less interest is accruing each year.

Many people, once they realise this, then worry that if they ever remortgage to another deal, they'll lose all the work they've put into decreasing what they owe. This isn't true. Provided you keep the same debt and the same number of years left until it ends (ie, you have 14 years left to repay and you still intend to repay it in 14 years) it stays the same.

To see how your repayments would work in practice, check out our Mortgage Calculator.

How does an interest-only mortgage work?

Interest-only mortgages used to be really popular among first-time buyers, but since the 2008 credit crunch it's been difficult to get your hands on one. And laws which came into effect in 2014 mean interest-only mortgages will only be offered where there's a credible plan to repay the capital, making them even rarer.

Here's how they work in brief:

With an interest-only mortgage you just pay the interest during the term. Your monthly payment doesn't chip away at your actual debt (the amount you borrowed) – it just covers the cost of borrowing that money. So for example, when the term (eg, 25 years) is up on a £150,000 mortgage, you would still owe £150,000.
You have to pay back the amount you borrowed in one lump sum at the end of the mortgage term. So if you get an interest-only mortgage, you NEED to have a separate plan to pay off your debt.

If you're considering an interest-only mortgage, the lender will want to see evidence of a convincing method you've set up (eg, savings) to build up enough cash to pay off the actual cost of the property.

So repayment wins hands down over an interest-only mortgage?

Putting the fact that it's difficult getting an interest-only mortgage aside, unless you have a compelling reason, repayment is really the way forward. That's because with a repayment mortgage:

Although you pay more each month, it's the only option which guarantees you owe nothing at the end of the mortgage term. That's as you're actually paying off some of your debt every month.
As the outstanding capital gradually reduces, you pay less interest over the term. Whereas with an interest-only mortgage, the amount of interest you pay never changes.
When you come to remortgage, you'll have paid off more of the debt. This means you'll be able to get a mortgage with a lower LTV and hopefully a lower interest rate.