Mortgages are a common type of option used to borrow funds by the use of an asset/property as security. Interest only and capital repayment mortgage are two different types of repaying the mortgage. The key difference between interest only and capital repayment mortgage is that interest only mortgages only contain a portion of monthly interest payment whereas monthly payments of capital repayment mortgage consist of both interest and capital component.
CONTENTS
1. Overview and Key Difference
2. What is Interest Only Mortgage
3. What is Capital Repayment Mortgage
4. Side by Side Comparison – Interest Only vs Capital Repayment Mortgage
5. Summary
What is Interest Only Mortgage?
With interest only mortgage, the monthly payments will only cover the interest payable on the loan. Payments will not include a capital portion to pay off the principal amount borrowed. With this kind of a mortgage, the borrower should arrange an adequate repayment vehicle such as a savings plan or other form of investment to pay off the principal amount at the end of the mortgage term.
This is an attractive option if the party taking the mortgage intends to sell the property at a future date since the proceeds of sale can be used to pay off the capital at the end of the mortgage term. Furthermore, they are cheaper compared to capital repayment mortgage. However, this option is less liked since a lump sum of funds is payable in a single installment.
What is Capital Repayment Mortgage?
With a capital repayment mortgage, the monthly payment will consist of a portion of interest and capital on loan. By the end of the agreed term, the borrower will have paid off the principal amount, provided all repayments are made when they are due.
E.g. ABC Company took out a loan for $15,300 in January 2017 with an interest rate of 10% for a period of one year
Monthly payments for the one year period can be computed as per below. (Amounts are rounded to the whole number)
The main advantage of capital repayment mortgage is that the property will belong to the borrower at the end of mortgage period and this is a convenient method since a lump sum of money is not payable with the final monthly payment.
Figure 1: Mortgage balance decreases gradually with a capital repayment mortgage
What is the difference between Interest Only and Capital Repayment Mortgage?
Interest Only vs Capital Repayment Mortgage |
|
| Interest only mortgages only contain the portion of monthly interest payment. | Capital repayment mortgage monthly payments consist of both interest and the capital component. |
| Monthly Payments | |
| In an interest only mortgage, monthly payments are low since only interest is paid. | This has to incur higher monthly payments since capital repayment portion is involved in addition to the interest. |
| Frequency of Capital Payments | |
| In an interest only mortgage, the entire amount of capital will be paid at the end of the mortgage period. | In a capital repayment mortgage, capital is repaid in a number of frequencies. |
Summary – Interest Only vs Capital Repayment Mortgage
The difference between interest only and capital repayment mortgage mainly depends on the components included in the monthly payments. If monthly interest is paid, then it will be classified as an interest only mortgage, and if a capital payment is also paid as a part of the monthly payment, then it is referred to as capital repayment mortgage. While both options consist of advantages and disadvantages, the suitability also significantly depend on the requirements of the borrower.
References:
1. “What is the difference between an Interest-Only Mortgage and a Repayment Mortgage paying capital and interest?” Mortgages & Savings from Hinckley & Rugby Building Society. N.p., n.d. Web. 17 Mar. 2017.
2. “Amortization Calculator.” Loan Amortization Calculator | Credit Karma. N.p., n.d. Web. 17 Mar. 2017.
3. “The pros and cons of interest-only mortgages.” Your Mortgage. N.p., 05 May 2015. Web. 19 Mar. 2017.
4. “Should you get an interest only or repayment mortgage?” Money.co.uk. N.p., n.d. Web. 19 Mar. 2017.
Image Courtesy:
1. “Mortgage balance” By Neil Parker (CC BY-SA 3.0) via Commons Wikipedia