What is a Capital and Interest Mortgage?

A capital and interest mortgage, commonly referred to as a “repayment” mortgage, is one of the most widely used types of mortgage by homeowners. This article explores what a capital and interest mortgage is, how it works, provides an example, outlines who can qualify, compares it to an interest-only mortgage, explains what a part-and-part mortgage is, and discusses the pros and cons of a capital and interest mortgage.

What is a Capital and Interest Mortgage?

A capital and interest or repayment mortgage is a loan secured against the borrower’s home where the borrower repays both the capital, i.e. the original amount borrowed, and the interest, i.e. the cost of the borrowing, over the entire term of the mortgage. This type of mortgage ensures that the entire loan amount is paid off in full along with all the interest by the end of the mortgage term, which is typically 25 to 30 years.

How Does It Work?

In a capital and interest mortgage, the monthly mortgage payment is a constant amount over the entire life of the mortgage at any given rate of interest. In reality, however, the mortgage interest rate is, on average, re-fixed every two to five years. Thus, the “constant” monthly mortgage payment amount changes each time the mortgage interest rate changes.  

The monthly mortgage payment is divided into two components:

1. Capital Repayment: This portion of the monthly mortgage payment amount is allocated to repaying the principal amount that was originally borrowed over the life of the mortgage. The outstanding balance of the mortgage decreases with each monthly payment.

2. Interest Payment: This portion of the monthly mortgage payment amount covers the interest charged by the lender on the mortgage loan. The interest is calculated each month on the outstanding principal balance of the mortgage. At any given interest rate, as the principal amount decreases, the amount of interest payable also decreases.  

At any given interest rate, the interest payment portion versus the capital repayment portion of the constant monthly mortgage payment amount changes every month. This is because the amount of interest paid each month as a proportion of the total amount of interest due over the life of the mortgage decreases each month, while the amount of capital repaid each month as a proportion of the total amount of capital due over the life of the mortgage increases each month.  

Hypothetical Example of a Capital and Interest Mortgage (H2)

Assume that the following terms apply to a hypothetical capital and interest mortgage:

Mortgage Amount: £200,000

Interest Rate: 5% per annum

Mortgage Term: 25 years

The constant monthly mortgage repayment amount would be £1,169.18 for each of the 300 monthly periods that would comprise the full mortgage term.  

The total amount of interest due over the life of the mortgage would be £150,754.02, while the total amount of capital due would be the original mortgage amount, i.e. £200,000.

A snapshot of the first six monthly mortgage payments (for Months 1 - 12) and the last six monthly payments (for Months 295 - 300) is set out in the table below:

While the monthly mortgage payment amount stays constant (column B), interest as a proportion of the monthly payment (column E) and, likewise, capital (column F) changes every month. Initially, as in months 1 – 6 (column A), the proportion of interest (column E) is greater in the monthly payment amount than capital (column F). However, later on, as in months 295 – 300 (column A), the proportion of capital (column F) is greater than interest (column E). The capital paid off each month as a proportion of the mortgage amount increases each month (column G), while the interest paid off each month as a proportion of the total interest due decreases (column H).

Who Can Qualify?

Most working age homeowners who can comfortably afford the monthly mortgage payments and meet the lender's criteria can qualify for a capital and interest mortgage. As well as evaluating the borrower’s property, lenders are typically likely to assess the following:

• Income and Employment Status: A stable income and employment history are important.

• Credit History: A good credit score increases the likelihood of approval.

• Deposit: Typically, a minimum deposit of 5% to 20% of the property’s value is required.

• Affordability: Lenders conduct stress tests to ensure borrowers can afford mortgage payments even if interest rates rise.

Comparison with an Interest-Only Mortgage

An interest-only mortgage differs significantly from a capital and interest mortgage. Here are the key differences:

• Repayments: In an interest-only mortgage, monthly payments cover only the interest, not the capital. This means that the capital must be repaid in full at the end of the mortgage term as a single lump sum, typically using savings or from the proceeds of the sale of the property or other investments.

• Monthly Payments: Monthly payments are lower with an interest-only mortgage because only the interest is paid.

• Risk: Interest-only mortgages carry more risk since there is no reduction in the capital over the mortgage term, leaving a large lump sum to be paid off at the end.

What is a Part-and-Part Mortgage?

A part-and-part mortgage is a hybrid between a capital and interest mortgage, and an interest-only mortgage. With this type of mortgage:

• Repayments: Part of the loan is repaid on a capital and interest basis, while the rest is repaid on an interest-only basis at the end.

• Flexibility: It offers more flexibility, allowing for lower monthly payments compared to a full repayment mortgage, but also ensures some reduction in the capital.  

This type of mortgage is beneficial for those who want lower monthly payments but still wish to reduce some of the loan balance over time.

Pros and Cons of a Capital and Interest Mortgage

Pros:

1. Full Repayment: At the conclusion of the mortgage term, the borrower will have completely paid off the mortgage, resulting in full ownership of the property without any outstanding debt.

2. Reduced Debt: As regular payments are made, the outstanding loan balance decreases, leading to a reduction in the overall amount of interest paid over the life of the mortgage. This helps borrowers save money and build equity in their property, over time.

Cons:

1. Increased Monthly Financial Obligation: With a repayment mortgage, the monthly payments are higher compared to interest-only mortgages. This can potentially put a strain on monthly budgets and require careful financial planning.

2. Long-Term Financial Commitment: Opting for a repayment mortgage entails a significant long-term financial commitment. This may not be suitable for individuals with fluctuating incomes or those who experience financial instability, as it requires a consistent and reliable income to manage the monthly payments effectively.

A capital and interest mortgage is a solid choice for those seeking to own their property outright by the end of the mortgage term. While it involves higher monthly payments compared to an interest-only mortgage, the benefits of full capital repayment and reduced interest make it a popular choice among homeowners. Before deciding, it is essential to assess your financial situation, future plans and risk tolerance. Consulting with a financial advisor or mortgage specialist can provide personalized insights and help you choose the best option available for your needs.

FAQs:

Q. What is a capital and interest mortgage, and how does it differ from an interest-only mortgage?

A: A capital and interest mortgage, also known as a “repayment” mortgage, involves paying off both the loan principal and the interest over the life of the mortgage. Thus, by the end of the mortgage term, the entire mortgage loan amount is paid off. By contrast, an interest-only mortgage requires only interest payments each month, with the principal due at the end of the mortgage term. This means the monthly payments are lower for an interest-only mortgage, but you need to have a robust plan to repay the principal at the end of the term.

Q. Who is eligible for a capital and interest mortgage?

A: Most working age homeowners who can demonstrate their ability to afford the monthly mortgage payments can qualify for a capital and interest mortgage. As well as evaluating the borrower’s property, lenders typically consider factors such as income, employment status, credit history and the size of the deposit. A good credit score and stable income can improve your chances of securing a mortgage with favourable terms.

Q. Can I switch from an interest-only mortgage to a capital and interest mortgage?

A: It is generally possible to switch from an interest-only mortgage to a capital and interest mortgage. This process typically involves remortgaging with your current lender or a new lender. It is important to consider the impact on your monthly payments, as these will increase to cover both the interest and the principal. Consulting with a mortgage advisor can help you understand the implications and find the best option.

Q. What are the main benefits and drawbacks of a capital and interest mortgage?

A: The main benefits of a capital and interest mortgage include full repayment of the loan by the end of the term and reduced interest costs over time. The main drawback is the higher monthly payment compared to an interest-only mortgage. However, an interest-only mortgage does require a large lumpsum repayment at the end of the mortgage term. It is essential to weigh the pros and cons based on your financial situation and goals. Consulting an independent financial advisor or mortgage broker may be advisable.