Interest Only v Repayment

In the beginning, the total payment consists mainly of interest, with only a small amount of capital being repaid but each month, as the payment of the Capital element reduces the outstanding loan balance, so the amount of interest chargeable also goes down and as the monthly payment does not change (if we ignore interest rate changes) the outstanding loan balance gradually reduces. This effect is not very noticeable in the beginning as the sums are quite small, and it would be true to say that relatively little is paid off the mortgage in the first few years and that most of the loan is repaid in the last 10 years (assuming a 25 year mortgage term).

There are several advantages with this method of repayment. Firstly, it is a good way to ensure that the loan is repaid at the end of its term, or before it if you make overpayments from time too time and do not borrow any additional amounts.

Secondly, as the size of the loan decreases more and more of the property value (equity) belongs to you. So if you move home, you may well have a bigger deposit next time. And, lastly, if house prices fall, at least what you owe is also going down and this offers protection against 'negative equity', which occurs when the value of the property is less than the amount you owe on it. When this happened back in the late eighties and early nineties, many people lost their homes as they could no longer afford to make the mortgage payments, and were not particularly inclined to do so anyway, on a house that was worth nothing to them.

Historically, people took out some form of savings plan designed to repay the Capital at the end of the mortgage term, usually an endowment life assurance policy which also protected the debt in the event that the mortgagor died during the term. The life assurance contained in the policy was sufficient to clear the original debt if this happened. In later years, other forms of savings plans emerged; Unit Trusts, ISAs, Pension Tax Free cash and so on.

They all had one thing in common; the amount at the end of the term was not guaranteed and the final value depended on the investment performance over the term selected. And we all saw what happened next. Suffice to say that there was an element of risk involved which may not always have been appreciated by those who chose this method but, to be fair, quite a few of these plans actually did produce sufficient to pay off the mortgage.

Everyone's circumstances are different and for some it will be one decision and for the rest it will be the other one. Some will choose interest only as they will pay off very little in the beginning and can always catch up later. Others will rely on an inheritance or will just cross their fingers and hope for the best or will sue their adviser if the result is not to their satisfaction. The calculator may help you to choose the answer that suits you.

The risk with interest only is considerable.
If house prices fall, they you may be caught out

out, and it is imperative that you understand as well as accept the risk before you commit themselves. You should not decide without discussing it first with an independent financial adviser, such as The Mortgage Shop.

The calculator will show the difference in cost between the two methods and, since the investment based mortgage costs about the same as the repayment alternative, it will give you an indication of the minimum that should be invested with a view to repaying the debt at the end of the mortgage. This should preferably not be less than about 20 years hence as these investments are not designed for short terms. Warning: it is only an indication as to the minimum amount to save. No indication that this will be enough is expressed or implied and we accept no responsibility for the outcome if you make that choice.

It will also quantify the cost of the risk of making no provision to make the eventual repayment.

The cost of life asurance is not a function of the calculator. If you want more information on that subject, please use the link at the foot of this page, on the left.

A repayment mortgage consists of two parts, both of which are paid simultaneously to the lender; the amount of the Capital which is being repaid to the lender that month and the amount of the interest on the remaining balance.

Interest Only does exactly what it says on the tin. You pay interest on the loan at whatever the current interest rate is and the amount of the loan stays exactly the same. Nothing is paid off the loan. If house prices go up, you own a bigger share of it and if they go down a smaller one, which is not without its dangers.

The Mortgage Shop is a retired IFA that no longer gives direct advice on or arranges Equity Release. Instead, it passes your enquiry to a fully qualified and licensed professional firm, in your local area, that
will do this for you. This is a FREE referral service to you, without any obligation, and you are completely at liberty to negotiate with the firm concerned the terms for their advice and services. The information provided is on the basis of our understanding of UK tax law and Inland Revenue practice and is subject to change. This site is intended for persons aged 18 or over, resident or ordinarily resident, in the United Kingdom. email: bobstark@mortgagefor.me.uk

This is about Equity Release Plans. To understand the features and risks, ask for a personalised illustration. The actual APR rate available will depend upon your circumstances.

Capital Repayment or Interest Only ?
This calculator compares the cost of an interest only mortgage to the cost of an equivalent capital and interest repayment mortgage.
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