What’s the best way to repay your mortgage?
When you take out a mortgage on a property, you’ll need to decide how to pay back the loan. In most circumstances, a ‘repayment’ mortgage is the most appropriate choice, and indeed it’s also the most commonly used. But there is another option available – interest-only. So what are the key differences and which is best for you?
There are two ways to pay off your mortgage. These are:
– Capital repayment (also known simply as ‘repayment’)
What’s the difference?
If you take out a repayment mortgage, each monthly payment is made up of both the interest on your mortgage and a portion of the loan itself. These monthly payments are calculated so that by the end of your full mortgage term, you will have paid off the whole loan.
However, if you take out an interest-only mortgage, as the name suggests, you only pay back the interest on your loan. You’ll need to ensure that you have enough money at the end of the mortgage term to pay off the outstanding balance. Most people using this method of repayment will invest their money elsewhere in order to build up the necessary capital to pay off the loan.
So what are the pros and cons?
• Less stress – above all, this method of repayment offers peace of mind. As long as you continue to make your monthly payments, you know that by the end of the mortgage term, you are guaranteed to be mortgage-free.
• Capital repayment is usually the cheaper option – you’ll pay less interest over the term with a repayment mortgage. Plus, as you pay off more of your loan and the equity in your home increases, you’ll get access to better interest rates.
• It’s simple – you only have to make one payment each month and there’s no need to worry about how to invest your money in order to find a lump sum at the end of the term.
• Higher monthly payments – although it’s the cheaper option over the long-term, you will pay more each month with a repayment mortgage and you must keep up with your monthly payments to avoid getting into arrears. If your circumstances change, this can be a worry.
• Less control – although making one monthly payment each month is the simpler option, it also means there’s no room for flexibility. The money goes to your lender every month, without exception (although some lenders do offer the option of a short-term payment holiday should you need it).
• Lower monthly payments – the main benefit of an interest-only mortgage is the fact that you are only paying back the interest on your loan, so your monthly payments will be far lower than with a repayment mortgage.
• Greater control – you’ll need to build up the necessary capital to pay off your mortgage at the end of the term, but it’s up to you to decide how to do that.
• This option also offers flexibility – in some months you could choose to put more into your savings/investments and in other months you could pay less, freeing up money to pay for a holiday or home improvements.
• Make money – if your investments do well, you could pay off your mortgage at the end of the term and still have some cash left over.
• More expensive – because you’re only paying the interest, and not reducing the amount of your loan, you’ll continue to pay interest on the full amount over the term of your mortgage, making this a more expensive option.
• Risk – if you only pay off the interest, you will still have the full loan amount to pay at the end of the mortgage term. If you don’t plan properly for this, or if your investments fail to perform as expected, you could end up owing your lender a substantial amount of money, and if you’re unable to pay it, you could lose your home.
Which option should you choose?
There’s a reason why most mortgages are now given on a ‘capital repayment’ basis – lenders see it as a much safer option for them. Unless you can show that you already have substantial savings, or can provide evidence of a high performing investment plan, your lender is likely to refuse requests for an interest-only mortgage. So for the majority of homebuyers, there isn’t really a choice to be made.
However, the exception to this rule is if you are taking out a buy-to-let mortgage.
Most buy-to-let mortgages are repaid on an interest-only basis, rather than repayment. That’s because in most cases, the property will be sold in order to pay off the mortgage.
Even this is not without risk, as any dips in the property market, either locally or nationally, can see the value of a buy-to-let property decrease.
If you’re thinking of buying a residential or buy-to-let property and would like to discuss how we can help with your conveyancing, just get in touch.