What is a repayment mortgage and how does it work?

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If you’re a homeowner, or in the process of buying your first home, you’ll know that the type of mortgage you choose can have major implications on what you pay in the long run.

Widely considered to be the most popular mortgage type in the UK, repayment mortgages are just one of the many loan types available to you when buying a house. When you take out a repayment mortgage, you are likely to pay back less overall compared to an interest-only mortgage, but that’s not all. Repayment mortgages come with an array of perks, considerations, and unique features worth taking into account.

In this guide, we’ll explore the ins and outs of repayment mortgages, so you can decide whether they make sense for your home ownership needs.

What is a repayment mortgage?

Repayment mortgages are a type of mortgage—loans designed for the purposes of buying a house—in which the capital you have borrowed and the interest owed are combined into a single monthly repayment.

In other words, with a repayment mortgage, you are repaying both the debt and any interest each month.

As long as you keep up with your repayments, you will pay off the entirety of your mortgage by the end of the agreed term.

How are repayment mortgages different to interest-only mortgages?

With an interest-only mortgage, you only need to pay the interest each month. At the end of the mortgage term, you will be required to repay the debt in full.

With a repayment mortgage, you’ll be repaying both the debt and the interest, taking a weight off your mind when it comes to the end of the mortgage.

How does a repayment mortgage work?

When you begin to pay off your repayment mortgage, the proportion of interest you repay monthly will be higher than that of the capital (the debt that needs to be repaid). This does mean that your loan amount will appear to decrease slowly in the first few years of your term.

As your term progresses this balance will shift and your capital payments will increase, reducing your interest. Your owed amount will start to decrease at a faster rate, and by the end of your term you will be mortgage-free and own your home outright—as long as you keep up these repayments.

What are the different types of repayment mortgages?

Repayment mortgages are not a ‘one-size-fits-all’ method of borrowing. Interest rates will vary depending on which mortgage type you choose, as will the loan term.

Fixed-rate mortgages

Fixed-rate mortgages refer to a mortgage for which the interest rate is set and unchanged for a period of time—often ranging from two to five years. This provides a period of security in the market of ever-changing and rising mortgage interest rates. Your repayments will remain the same amount each month until your fixed-rate term ends, at which point your interest rate will revert to the standard variable rate.

Variable rate mortgages

All mortgage lenders will offer a standard variable rate (SVR) mortgage. In this case, interest rates on mortgages are almost guaranteed to change during your term—rates and repayments are also likely to be higher than with other mortgage options. 

It is possible to take out an SVR mortgage initially, though this is rare. It is more common to switch to an SVR once your other mortgage option—such as a fixed-rate mortgage—comes to an end.

A variable-rate mortgage is a flexible option, usually with no obligation to stick with your plan if you decide to move to another provider or mortgage option. Due to the ever-changing nature of a variable mortgage, budgeting can be difficult as your outgoings may be different each month. This is something to think about when considering an SVR mortgage.

Tracker mortgages

Similar to a variable rate mortgage, a tracker mortgage does not have a fixed interest rate. This means your mortgage repayments may increase or decrease month-on-month. 

Where SVR mortgage interest rates are down to the lender’s discretion, tracker mortgages usually adjust your rates according to the Bank of England’s base rate—this is reviewed on the first Thursday of every month.

Tracker mortgages are usually set for a fixed-term, meaning if you wish to change your mortgage plan or pay it off early, you may encounter an early repayment charge (ERC).

Discount mortgages

Discount mortgage rates will rise and fall, as with an SVR, though rates are set at a lower percentage. This means your repayments will be cheaper throughout your loan term. Discounted mortgages may either be fixed for a specified term—such as three or five years—or remain throughout the entire mortgage period.

How are repayment mortgages calculated?

Being the most popular mortgage choice, it’s safe to say that repayment mortgages come with an array of benefits. These include but are not limited to:

  • As long as you keep up monthly repayments, your mortgage is guaranteed to be paid off in full at the end of your term meaning you will be the sole owner of your home
  • As you pay off capital, the equity you have in your property will increase—if you decide to remortgage or move home it should be easier to obtain a new mortgage
  • Your overall payment may be less than with a interest-only mortgage—as what you owe overall decreases, so will your interest payments

What are the disadvantages of a repayment mortgage?

No loan comes without considerations, and a repayment mortgage is no exception to this. Before you think about applying, take a look at some of the disadvantages you may encounter with a repayment mortgage:

  • Higher monthly payments—you are paying capital and interest at the same time
  • In the early years, capital is paid off in smaller amounts so your outstanding loan amount will reduce slowly at first

Can I switch from a repayment to an interest-only mortgage (and vice versa)?

An interest-only mortgage differs from a repayment mortgage in that you only pay off the interest on your loan, not the capital. This means once your loan term ends, you must pay off the borrowed amount in full—either as a lump sum or by selling your property.

If you are looking to reduce your monthly repayments, switching to an interest-only mortgage is one way to do so. You will encounter checks to ensure that you are able to make regular repayments, including a credit check, how much equity you have in your property, and what your repayment strategy will be.

Interest-only mortgages do not work for everyone. Be sure to consider the risk, and explore your options before you commit to making this switch.

On the other hand, if you have an interest-only mortgage you do have the option to switch to a repayment mortgage. This tends to be a lot easier than the opposite, as the risk for lenders is less. The main thing to remember is that your monthly repayments will increase, so you may need to prove that you can afford this jump.

Find the best mortgage for you

Still unsure if a repayment mortgage is right for you? Browse your mortgage options and speak to an adviser to make the best decision for your needs.

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