What is an interest only mortgage?
It’s a type of mortgage where you only repay the interest on your outstanding balance every month, not the capital.
Interest only mortgages are particularly popular with buy to let investors in Ireland because they keep their payments low while they earn rent from their tenants.
However, they can also be taken out by other borrowers in limited circumstances, for example homeowners struggling with mortgage arrears.
How do interest only mortgages work?
When you borrow using an interest only mortgage, at the end of the term, you’ll still owe the original amount you borrowed.
This means you’ll need to have another way to repay the balance when it’s due - this is sometimes called a repayment strategy.
Types of interest only mortgages in Ireland
In Ireland there are two main types of interest only mortgages:
- Pension mortgages
- Endowment mortgages
With a pension mortgage you plan to pay off your mortgage balance at the end of your term using a personal pension policy. During the term of your mortgage you’ll have to pay:
- The interest on your mortgage balance
- Regular contributions into a pension fund alongside your mortgage
This pension fund should grow in value over the term of your mortgage both through the contributions you make and the investment performance of the pension fund itself. Pension mortgages are designed to both:
- Clear your mortgage balance when you retire
- Provide a retirement income
However this is not guaranteed, if it performs poorly there is a risk your policy may not be worth enough to pay off your mortgage, also leaving you with less money in retirement.
With an endowment mortgage the aim is to pay off the mortgage balance at the end of your term using an investment policy called an endowment.
At the end of your mortgage term you close or cash in your endowment and use the funds to pay off your outstanding mortgage balance.
However, how much your endowment policy is worth depends on the investment performance of the endowment fund. If your endowment performs poorly it may not be enough to pay off what you owe.
Other ways to pay off the balance
How you pay off the mortgage balance is often based in part on the type of interest only mortgage you choose, but can also include other arrangements like:
- Saving and investing where you put aside a regular amount to build up a fund large enough to pay off the balance. This allows you to benefit from interest payments and the growth of your investments but also comes with risk if your investments perform poorly.
- Selling your property and downsizing to a smaller home. This could release some funds to pay off some of what you owe, but you’ll need to consider where you’ll live after selling and whether this is a viable option.
- Making overpayments alongside your mortgage to reduce your balance. This could reduce what you owe and offer flexibility to make payments when you have the funds to do so, but there are overpayment limits and rules you’ll need to follow.
You don’t have to pick just one of these options. Your repayment strategy could include a combination of different options to pay off your mortgage balance.
If you’re considering an interest only mortgage, you may wish to consider taking independent financial advice to help set up your repayment strategy.
Tracking your repayment strategy
If you already have an interest only mortgage, you need to regularly review how your repayment strategy is performing to ensure you’re on track.
This will allow you to make adjustments if it looks like there will be a shortfall.
Interest only vs repayment mortgages
Repayment and interest only are the two main types of mortgages in Ireland. The main difference relates to what’s included in your mortgage repayments:
- With an interest only mortgage you only pay the interest you owe on your mortgage balance each month.
- With a repayment mortgage you pay the interest and some money off what you owe each month. This means, at the end of your mortgage term, your balance will be zero.
Which should you choose?
If you’re a first-time buyer or a home mover a repayment mortgage is the most common option. Many mortgage lenders in Ireland simply won’t offer you an interest only option because they’re deemed to be a riskier choice.
However, if you’re buying a property to rent out then an interest only investment mortgage could be worth considering. Here are some of the pros and cons of each option:
Interest only pros & cons
- Cheaper monthly payments
- Free up funds to invest or save
- Doesn’t reduce what you owe
- Harder to overpay
- Limited options to choose from
- You need a repayment strategy
Repayment pros & cons
- Pays off your mortgage balance
- More choice of products
- Easier to overpay
- Higher monthly payments
- Less money to save or invest
Can you change to a repayment mortgage?
Yes, you can usually re-mortgage and switch to a repayment mortgage, as long as you meet all the lenders affordability criteria.
You could also choose to move part of your balance onto a repayment mortgage and leave some on your existing interest only mortgage.
Interest only mortgage FAQs
Can I extend my interest only mortgage term?
This will depend on your individual circumstances but may be possible.
Extending your term will increase the amount you have to pay in interest over the course of your mortgage, but it could also give you more time to raise the funds you need to pay off the final mortgage balance.
If you’re thinking about extending the term of your interest only mortgage you should consider seeking independent financial advice first.
Can I get a part interest only and part repayment mortgage?
Yes, some lenders do offer a split mortgage, where part of what you owe is interest only and part is repayment.
Do I need mortgage protection insurance for an interest only mortgage?
Yes, you still need a valid mortgage protection policy if you choose an interest only mortgage.
Our guide to mortgage protection insurance covers the different types of insurance and which are best suited to interest only borrowers.
Do I still need a deposit for an interest only mortgage?
Yes, the same mortgage deposit rules apply to interest only and repayment mortgages.
Is an interest only mortgage cheaper than a repayment mortgage?
This depends on your circumstances and the performance of your repayment strategy.
Your monthly mortgage payments will be lower than with a repayment mortgage, but because this payment doesn’t reduce what you owe, you’ll also need to pay into a repayment strategy as well.
What happens when my interest only mortgage ends?
Your monthly repayments will stop and the full mortgage balance will need to be paid back to the lender.
As you approach the end of your mortgage term you will need to arrange for the money in your repayment strategy to be ready, for example cashing in your endowment policy.
Your mortgage lender should also contact you before the money is due to explain how repaying your balance works.