Mortgages can be arranged via three different payment options. These are called repayment methods and include capital repayment, interest-only and part and part. Capital repayment involves paying down the mortgage (reducing the capital), as well as paying the interest. Interest-only, as its name suggests, involves paying purely the interest. A part and part mortgage is where a proportion of the loan is on capital repayment and the remaining portion is on interest-only – a combination of two repayment methods.
Capital repayment mortgages, often simply referred to as repayment, have higher monthly payments but at the end of the mortgage term, the mortgage is repaid. Interest-only mortgages have lower monthly payments but at the end of the mortgage term, the full mortgage amount is still owed and must then be repaid.
Repayment mortgages are the most common, most available and most accessible mortgages for purchasing residential properties. In contrast, for buy-to-let mortgages when purchasing rental property, repayment and interest-only are equally as accessible. Interest-only mortgages are actually more common with rental affordability calculations and the short-term prospect of generating higher monthly income pushing people towards the interest-only option.
Purchasing a residential property on an interest-only basis has become a very niche area of the mortgage market. Nowadays, particularly given the current extended period of low interest rates, these mortgages aren’t designed for everyone. Residential interest-only mortgages are more commonly associated with the upper end of the mortgage market. This is due to the criteria and regulatory requirements surrounding this type of lending.
There are four main pieces of criteria which determine eligibility for interest only lending.
- Maximum Loan-to-Value (LTV)
- Minimum Income
- Minimum Equity
- Repayment Vehicle
Naturally, how these variables are viewed and the specific figures and criteria associated with them are different between each mortgage lender. Hence, giving approximate criteria would not be worthwhile. One lender may have no minimum income criteria while allowing repayment strategy ‘A’. Another lender may require a high minimum income but not allow repayment strategy ‘A’. What can be said is that these types of mortgages are generally limited to a low LTV, require a high annual household income (six figures and above) and require a significant amount of equity in the property. Acceptable repayment strategies vary between lenders and are often assessed on individual merit. Repaying an interest-only mortgage by way of moving to a smaller property, ‘downsizing’, is often not considered an acceptable repayment strategy to obtain an interest-only mortgage.
We see two reasons for people looking for an interest-only mortgage on a residential property, more than any others. Either people want to make their money work harder elsewhere or they cannot/do not want to make the monthly payments if the mortgage were to be on a repayment basis. “Making you money work harder elsewhere” refers to the idea of devoting money into investments that will earn a higher rate of interest than is being paid on the mortgage. This principle is the reason why many high-net-worth individuals choose to have mortgages when they could easily afford to pay them off.
If you’re thinking about an interest-only mortgage and want to understand whether you’d be eligible and whether it’s something that could be right for you, feel free to get in touch for free professional mortgage advice.