Finance⏱ 5 min read
How to Calculate an Interest-Only Mortgage Payment
Interest-only mortgages have much lower monthly payments than repayment mortgages -- but the debt never reduces. Here is the full comparison, the risks, and who they genuinely suit.
An interest-only mortgage charges you only for borrowing the money -- the loan itself stays the same. Monthly payments can be 40-60% lower than a repayment mortgage on the same sum, which is why they appeal. But the entire debt remains outstanding at the end of the term.
Interest-Only Monthly Payment Formula
Monthly payment = Loan amount x (Annual interest rate / 12)
Example: £250,000 loan at 4.5% annual rate
Monthly payment = £250,000 x (4.5% / 12)
= £250,000 x 0.00375
= £937.50/month
This £937.50 covers ONLY the interest.
After 25 years of payments, the outstanding balance is still £250,000.
Repayment mortgage comparison (same loan, rate, term):
Monthly payment = approximately £1,389/month (principal + interest)
After 25 years: outstanding balance = £0
Savings per month (interest-only): £1,389 - £938 = £451/month
Total "savings" over 25 years: £451 x 300 = £135,300
But: you still owe £250,000 at the end -- net position is worse.
Repayment Vehicle Requirements
Mortgage lenders now require a credible repayment strategy for interest-only:
Acceptable repayment vehicles:
- Endowment policy (now rare)
- Stocks and Shares ISA or investment portfolio
- Sale of the property (downsizing)
- Pension lump sum
- Sale of another property
ISA/investment repayment plan:
Need to accumulate £250,000 by end of term.
25-year term, starting now, 6% annual return:
Monthly investment needed: PMT = 250,000 x (0.005 / ((1.005)^300 - 1))
= 250,000 x (0.005 / (4.4677 - 1))
= 250,000 x 0.001442
= £360.50/month
Interest-only payment + repayment vehicle:
£937.50 + £360.50 = £1,298/month
vs repayment: £1,389/month
Difference: only £91/month -- for much higher risk.
Who Interest-Only Genuinely Suits
- Buy-to-let landlords: Interest payments are fully tax-deductible (after the Section 24 transition). Capital growth serves as the repayment vehicle on exit.
- High earners with erratic income: Large bonuses can periodically reduce the principal; low base payments avoid cash flow crises.
- Downsizers approaching retirement: Will sell a larger property to repay the mortgage plus have equity remaining.
- Short-term bridge finance: Interest-only bridging loans bridge between property transactions.
The Lender Restrictions
Since 2012 (MMR rules), lenders have tightened interest-only lending:
Typically require:
Loan-to-Value: maximum 75-80% (some lenders 50-60%)
Minimum loan: often £250,000-£300,000
Demonstrable repayment strategy with evidence
Higher income requirements than equivalent repayment mortgage
Very few lenders offer interest-only on residential mortgages now.
Availability: approximately 10-15% of mortgage products (was 50%+ pre-2008)
Where still available: typically specialist lenders and private banks.