• Chris Warner

Mortgage repayment methods

Updated: Mar 25, 2021

There are three main mortgage repayment types: Capital & interest or repayment, Interest only and Part & Part repayment? Confused? Let’s see if we can help you understand the different ways in which you can repay your mortgage. I will try to explain these in greater detail to give you a better understanding of how they work and why clients may choose different approaches.

Firstly, and most commonly we have Capital & interest or it is also know as a repayment mortgage. A repayment mortgage means that you will be paying back your mortgage interest and a portion of the capital amount (original mortgage loan amount taken) with every repayment made. Eventually at the end of the chosen mortgage term you will have repaid the original loan amount taken and all accrued interest. This is the way in which most mortgages will be set up so that you have a guarantee that you will be able to fully repay your mortgage (as long as all mortgage payments have been made and on time).

The graph below will help explain how the amount of interest you pay over the term of the loan reduces as the capital amount is repaid. Eventually you reach a tipping point during your loan term where your monthly mortgage payment will be repaying more capital than interest. During the initial few years of a new mortgage very little capital is repaid.

Interest Only is the second most common method of paying a mortgage. As the name implies it means that you will be only paying back the mortgage interest accrued on a monthly basis and the original amount of mortgage taken will remain outstanding by the end of the term of the mortgage and need to be repaid in one lump sum.

Provision must be made to be able to repay this original mortgage amount and this is known as a repayment strategy. Lenders will want to know during the application process how you plan to repay the mortgage at the end of the term. There are various ways in which mortgage lenders will allow you to make provision to repay this debt, these can be ISA’s, Savings or investments, selling another property owned or pensions and other assets right through to selling the property at the end of the term. This is not usually an acceptable repayment plan for residential mortgages as you will be relying on capital growth of the property, it can be accepted for buy to let mortgages.

Historically, large numbers of interest only residential mortgages were taken out in the 1980’s and 1990’s and were backed by an endowment policy, savings or pension. Endowment policies were investment products sold by life insurance companies where you made regular monthly or annual payments over a set term (which usually matched the term of the interest only mortgage taken) and they were supposed to pay out an amount of money. The investment included life assurance, so the mortgagor was covered in the event of death too. However, large numbers of endowment policies under-performed and policy holders were left with huge gaps between what was due to pay out and the mortgage amount outstanding.

Typically, now days, mortgage lenders only allow interest only to be used for residential mortgages below 50%.

As briefly mentioned above, buy to let mortgages can typically be taken on an interest only basis and is a very common practice. More information on Buy to Let mortgages can be found here.

Lastly on our list is a part & part repayment mortgage. This is where the client chooses to repay some of the mortgage on a full capital repayment basis and some of the mortgage on an interest only basis. This will mean at the end of the chosen mortgage term there will still be a lump sum outstanding that will need to be repaid. This method of repayment can be chosen for any number of reasons but mainly due to the clients knowing a large lump sum like an inheritance or pension, for example, will be coming available further in the future and they want to save on their monthly repayments now by taking the interest only element on some of the mortgage loan. This type of repayment method offers an element of flexibility for clients and can be tailored to your individual set of circumstances.

If you wish to discuss mortgage repayment types further or have any queries with the content of this article, please do get in touch.

Please remember, your home may be repossessed if you do not keep up repayments on your mortgage or any loan secured against it.

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