When applying for a mortgage you will need to tell the lender how you intend to repay it.
There are 2 options:
- Repayment mortgage
- Interest only mortgage
Here we will look at repayment mortgages which are also known as capital and interest mortgages. What they are and how they work.
What is a repayment mortgage?
A repayment mortgage is the most popular method of paying back a mortgage.
With a repayment mortgage you repay the amount borrowed (the capital) plus the interest over the mortgage term. Each month you pay interest and some of the capital off.
This does mean that the repayments are higher than an interest-only option, but the debt is gradually being paid off.
How do they work?
The repayment of your mortgage is calculated over the term you have chosen (ie 25 years).
The lender works out how much interest and how much capital you need to pay to keep on track. In the beginning you won’t be paying much capital off but after a few years this changes so that more of the monthly payment going towards paying back the debt.
This is combined into one monthly payment by your lender.
So as each year of the mortgage term passes your outstanding mortgage amount gradually reduces.
The chart below shows how the mortgage balance changes each year.
The FCA estimates that 88% of mortgages are on a capital & interest repayment basis.
Capital and interest repayment mortgages are chosen by the majority of people applying for residential mortgages.
The monthly cost is more than an interest only mortgage but you always know that you mortgage will be repaid on time.
Here’s a quick example showing the different monthly payments for the same initial mortgage.
£200,000 borrowed over 25 years at 3.50%
| REPAYMENT METHOD | MONTHLY PAYMENT |
|---|---|
| Interest only | £584 |
| Repayment | £1002 |
Advantages and disadvantages of repayment
ADVANTAGES
The overriding advantage is that your mortgage is being paid back, month by month and each year your annual mortgage statement will show the balance decreasing. This happens quite slowly in the first few years and gradually speeds up. If you have an interest only mortgage then it is possible to convert this to repayment, so that the debt starts to be repaid.
DISADVANTAGES
The main disadvantage is that the monthly payments are higher than an interest only mortgage and the lender will be expecting the full amount. So it is a more rigid type of mortgage but most people accept this as it provides certainty of repayment.
Part and Part repayment method
It is possible to combine a repayment mortgage with an interest only mortgage, this is known as ‘part and part’.
For example:
£100,000 – Interest only
£100,000 – Repayment
£200,000 – Total mortgage
Read more: Part and part mortgages explained.
Interest only mortgage vs repayment: Which is best?
We take a closer look at the differences between interest-only and repayment mortgages, including the pros and cons of each option. We will also discuss the factors that borrowers should consider when making a decision about which type of mortgage is right for them.
Can you change your mortgage to interest only?
There are both pros and cons for switching your mortgage type, and there are also certain conditions which must be met in order for it to be possible. In this article we’ll explore what those conditions are and how changing from repayment to interest-only could affect your financial situation in the long run.