How does an interest-only mortgage work?
Each month your payment covers only the interest the lender charges. None of the original loan, the capital, gets paid off while the term runs. When the term ends, you hand back the full amount you borrowed in one lump sum.
Take a £200,000 loan at 4% over 25 years. On interest-only, the monthly payment works out at roughly £667. Set up as a repayment mortgage, the same loan costs around £1,056 a month. That gap is large, but remember the whole £200,000 is still outstanding when the interest-only term ends. To try your own numbers, use our repayment calculator.
This works best for borrowers with a genuine plan to clear the capital, perhaps from investments, selling a property, or a pension lump sum. Without a repayment vehicle that stands up, you can reach the end of the term facing a debt you have no way to settle.
Who is eligible for an interest-only mortgage?
Lenders have raised the bar on interest-only in recent years. Most look for a minimum income, often £75,000 or more where you are applying jointly, plus a large equity stake in the property, usually somewhere between 25% and 50%. On top of that, some set a minimum loan size or a maximum age.
You also have to show a credible repayment vehicle. A lender wants evidence that your plan for repaying the capital is realistic and stands a fair chance of producing the money needed by the time the term ends.
Advantages of interest-only mortgages
The obvious draw is the lower monthly payment, which leaves more cash free for other things. High earners might invest the difference, buy-to-let landlords often use it to protect their rental yield, and people whose income arrives unevenly get a smaller fixed commitment to plan around.
There is flexibility here too. A number of lenders let you move between interest-only and repayment partway through, or make one-off capital payments whenever it suits you. That helps if your income rises and falls, or if you want to set your own pace for chipping away at the balance.
Tax can come into it for some borrowers. Mortgage interest tax relief on residential homes has been phased out, but buy-to-let investors can still set some of their mortgage interest against rental income.
Risks to be aware of
The main danger is getting to the end of the term short of the money you need to repay the capital. An investment that underperforms, a dip in property values, or a change in your own circumstances can all leave a shortfall. Lenders check in with you from time to time to make sure your repayment vehicle is keeping pace.
Because your payments never touch the capital, you build no equity through them. If prices stay flat or slip, you can fall into negative equity, where the loan is bigger than the property is worth. That risk sits heaviest in the early years.