In a typical loan arrangement, the borrower commits to repay interest and principal on a regular basis so that the loan is cleared over its term. This is the structure of a repayment mortgage. Each monthly repayment consists of a bit of interest and a bit of capital. The split varies – in the early years the majority of each payment is interest to reflect the large amount of capital outstanding. In the latter years, most of every repayment is capital.
However, there is another type of mortgage where the repayment pattern is different – the interest-only mortgage. Here, the borrower just pays off interest charges on a monthly basis. As such, the repayment to the lender is smaller. Then, at the end of the term of the loan – say 25 years – the capital is repaid in one chunk.
This is also known as a ‘bullet repayment loan’. The lender will normally expect the borrower to have a savings plan in place from the start of the loan that will fund the final repayment of capital.
• See Tim Bennett’s video tutorial: Beginner’s guide to mortgages.