Capital Repayment vs Interest Only

Most mortgages you'll encounter on a residential basis will be a capital repayment mortgage. This simply means that along with the interest you will pay for the loan, a portion of your payment will also go towards repaying your mortgage. 

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The percentage of the total monthly payment that repays, what we call, the principal loan will increase as time goes on.

This is because, as time goes on, your loan will get smaller. Interest is charged daily on the loan you have left.

 

Your payment will remain similar as the repayment is calculated across the total length of the term. So, naturally, as the term dwindles, the amount of interest due in your payments will decrease and the amount you repay will increase. 

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The other option is an Interest Only Mortgage. 

An interest only mortgage is where you do not pay anything towards the principal loan. Instead you retain the total amount of the loan and pay only the interest charge each month. 

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This may seem counterproductive, however, interest only has it's uses. 

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Many people will use interest only mortgages to reduce costs. They are used prolifically in the Buy to Let market for landlords that want to extract as much as they can as an income and are not worried about repaying the mortgage. 

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They can also be used on property renovation projects to keep payments to a minimum while they complete the build and then remortgage or sell. 

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Interest Only mortgages are rarely used for residential mortgages, if they are, borrowers would need to have a large portion of equity in the property and be a high net worth individual. 

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The reason they are not usually used for a residential property is because they are so risky. Before now, they were used a lot for residential mortgages, we're still finding that homeowners are getting to retirement and still have their entire loan intact. In later life with only pension income this is a problem. 

 

Another measure put in place to mitigate this risk is the lenders requiring details of the repayment strategy to ensure that the loan will be repaid by retirement. 

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I hope that helps to give a little bit of insight into the differences with these types of mortgages. 

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As always, please do give us a ring if you would ever like to talk this through along with any other options.