If you are applying for a mortgage, you’ll likely have to choose between an interest-only mortgage or a straightforward repayment. Although interest-only mortgages are the most popular form of buy-to-let mortgages, make sure to understand the pros and cons of it before proceeding.
What Is the Difference Between Interest-Only Mortgage and Repayment?
With a repayment mortgage, during each month you are paying both the interest and a portion of your mortgage value (also called principal). For instance, if you took out a £1,000,000 mortgage, lent out over 10 years, then you will need to pay £100,000 each year on top of the interest you are paying. Under a repayment mortgage, you will own your property outright once your mortgage is paid off.
WIth an interest-only mortgage, you are only paying the interest each month, not the total amount owed. This means that your monthly payments are lower, but you still owe the value of the mortgage at the end of the term. When the term ends, you’ll need to repay the whole mortgage balance, either via an investment fund, cash savings or by selling the property.
With a repayment mortgage, you slowly pay off the value of your mortgage. With an interest-only mortgage, you wait until the very end of the term to pay your mortgage off in full.
Most buy-to-let landlords go through the interest-only mortgage route, as monthly payments are lower (so it is easier to use rental income to pay off monthly payments), and they will look to sell when the mortgage term ends.
What Are the Pros and Cons of an Interest-only Mortgage?
The Advantages Of an Interest-Only Mortgage
The main advantage of this mortgage is that the monthly payments are lower, and you might be able to sell the property at the end of the term at a profit. Lower monthly payments also provide a safety net for buy-to-let landlords - if the property is vacant, they are less reliant on rent to meet their obligations.
The Disadvantages Of an Interest-Only Mortgage
Unfortunately, with an interest-only mortgage, you will still owe 100% of the money you’ve borrowed at the end of the term. If something goes wrong and the property loses value, you may face considerable losses when you sell to settle the mortgage.
The interest rate on an interest-only loan is also more likely to be more expensive than a repayment loan.
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