Repayment vs interest-only mortgages
Here’s how repayment and interest-only mortgages work in Ireland and the different ways to repay your mortgage loan whether you’re a first time buyer, buy-to-let investor or switcher.
What’s the difference between a repayment and interest-only mortgage?
There are two main ways of paying for your mortgage in Ireland.
- Repayment mortgage: The sum you’ve borrowed, plus interest, is gradually repaid over your chosen mortgage term on a monthly basis. Most residential housebuyers repay their loan this way.
- Interest-only mortgage: You’ll only pay the mortgage interest during the term and the capital is repaid in one lump sum at the end. Buy to let investors may choose this option and it’s sometimes offered to self-builders for a limited period.
What is a repayment mortgage?
It’s a type of mortgage where you pay off the money you’ve borrowed and any interest charged on the loan over a set period.
Payments are monthly and typically spread between 24 and 30 years*, although this can be as little as 5 or as much as 35 years.
Repayment mortgages cost more than an interest-only mortgage on a monthly basis.
At the start of the term, a greater share of the payment is interest, however, when you get to the end of your mortgage term the loan is paid off entirely and you’ll own the property outright.
* Source: Central Bank of Ireland’s Household Credit Market Report 2020
Repayment mortgages pros and cons
- Reduces your mortgage balance
- More choice of mortgages
- Easier to overpay
- More flexible
- Higher monthly payments
- Less money to save or invest
What is an interest-only mortgage?
It’s a type of mortgage offered to buy to let investors in Ireland. They’re no longer available to residential borrowers because they’re perceived as too risky, although self-build mortgages can be offered as interest-only for the build period.
With interest-only mortgages, your monthly repayment covers only the interest owed on the balance, not the capital borrowed. This means monthly payments are lower, but you’ll still need to pay off the original loan at the end of the mortgage term.
To repay the capital you’ll need to have a plan to repay the balance at the end of the term - this is often called a repayment strategy which you’ll need to review periodically.
Some lenders may also offer flexible, repayment and interest-only mortgages to property investors.
Interest-only mortgages pros and cons
- Cheaper monthly payments
- Frees up funds to invest
- Can be more tax efficient
- Doesn’t reduce what you owe
- Stricter lending criteria
- Larger deposit required
- Shorter terms offered
- You need a repayment strategy
Types of repayment strategy
In Ireland, there are several ways to repay the capital you owe at the end of the mortgage term if you choose an interest-only mortgage.
Many landlords choose an interest-only mortgage because rental income usually covers monthly interest and buy to let properties are a long-term investment. An interest-only mortgage also means lower overheads for landlords who may need to maintain one or many properties.
Buy to let investors typically make a profit from house price rises which is used to repay the capital owed, but this is not guaranteed and depends on a healthy housing market.
An endowment policy is a type of investment taken out with a life insurance company. Money is paid into the policy each month for a set period of time, and this money is invested.
The policy will pay out a lump sum at the end of the term and the funds are used to pay off the outstanding mortgage balance. However, the value of an endowment policy depends on the investment of the fund. If an endowment performs poorly it may not be enough to pay off what is owed.
Pension mortgages are similar to endowment mortgages, however, a pension pot supports the mortgage instead of an endowment policy. The lump-sum part of the pension is used to repay the mortgage capital at the end of the term, set to coincide with retirement.
This type of mortgage is usually only for self-employed borrowers or company directors.
If you’re a buy to let investor and considering an interest-only mortgage, you may wish to consider taking financial advice to help set up your repayment strategy.
Can you change interest-only 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.
Switching to a repayment mortgage will increase your monthly payments. To keep your payments affordable, you may consider extending your mortgage term but bear in mind you’ll pay more interest over the term of the mortgage if you increase the term.
Another option is to move part of your balance onto a repayment mortgage and leave some on your existing interest-only mortgage.
What if you can’t repay your mortgage?
Under the Central Bank of Ireland’s Code of Conduct on Mortgage Arrears banks have to set in motion a process called the Mortgage Arrears Resolution Process (MARP) to help customers whose mortgage is in arrears or is at risk of going into arrears.
The lender has to offer you an alternative repayment arrangement and formally review the arrangement at least every 6 months. This review includes checking whether your circumstances have changed since the start of the arrangement or since the last review.
Alternative repayment arrangements
Moratorium or repayment break: This allows you to defer paying all or part of your mortgage for an agreed, limited time. At the end of the deferment period, your repayments will increase. If your payments are less than the interest amount due, your capital balance will also increase.
Capitalisation of arrears: Where your outstanding arrears may be added to the remaining capital balance, allowing you to repay them both over the life of your mortgage. This means that your mortgage will no longer be in arrears but this will increase the capital and interest repayments over the total life of your mortgage.
Mortgage term extension: This allows you to reduce your monthly repayments but your mortgage will last longer. It will result in you paying more interest over the life of your mortgage so it will cost more in total.
Interest-only arrangement: This is where you pay only the interest on your mortgage for a specified limited period of time. This means your capital balance will not reduce during the arrangement and your monthly repayments will increase once the arrangement period has ended.
Part capital and interest arrangement: This allows you to pay the full interest on your mortgage as well as make part repayments towards your mortgage balance for the remaining term of the mortgage.
Split mortgage arrangement: This arrangement splits your mortgage into two accounts to reduce your monthly repayments. You’ll be required to make capital and interest repayments based on your current financial circumstances for one part and the other part is “warehoused” and payment is deferred for a period of time until your financial circumstances improve.
At the end of the mortgage term, the outstanding mortgage balance will be due regardless of the alternative repayment arrangement.
If you are not in a position to repay the outstanding mortgage in full, you will need to talk to your bank about the options available, which may include, downsizing your property, mortgage to rent, or selling your home.
If you’re struggling financially or are worried about your mortgage, contact your lender or the Money Advice & Budgeting Service to talk about your options.
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Interest only mortgage FAQs
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 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.
What is the Mortgage Arrears Resolution Process (MARP)?
Under the Central Bank’s Code of Conduct on Mortgage Arrears (CCMA), lenders must operate a Mortgage Arrears Resolution Process (MARP) when dealing with customers in arrears or at risk of arrears.
The 4 steps of the MARP are communication, financial information, assessment and resolution. This means you must always get:
- A clear written explanation of how the proposed alternative repayment arrangement works
- Information on the impact on the mortgage term, the current balance outstanding and the existing arrears
- Your new repayment amount, how interest is applied and the term of the arrangement
- How the Irish Credit Bureau is informed and the impact on your credit record