How Interest and Repayment Mortgages Work
Buying a home is one of the biggest financial commitments many people make, and understanding how mortgages work is essential. Mortgages can seem complicated, but breaking them down into their components—interest and repayment—makes it easier to grasp. There are two main types of mortgages: repayment mortgages and interest-only mortgages.
Repayment Mortgages (Capital + Interest)
A repayment mortgage is the most common type of home loan. With this mortgage, your monthly payments cover both the interest on the loan and part of the principal—the amount you originally borrowed.
At the start of your mortgage term, most of your payment goes toward paying interest, with a smaller portion reducing the principal. As time passes, the balance gradually shifts: more of your payment goes toward the principal, and less toward interest. By the end of the mortgage term, your loan is fully repaid.
Example:
- Loan amount: $200,000
- Interest rate: 5% per year
- Term: 25 years
Each month, you pay a fixed amount that covers both interest and principal. Over 25 years, your $200,000 loan is fully repaid, along with all interest charges.
Key Benefit: Repayment mortgages are safer because you build equity in your home over time, reducing financial risk.
Interest-Only Mortgages
Interest-only mortgages work differently. Here, your monthly payments cover only the interest on the loan. The principal remains unchanged throughout the term, meaning you must have a plan to repay it at the end, such as selling the property or using savings or investments.
Example:
- Loan amount: $200,000
- Interest rate: 5% per year
- Term: 25 years
Your monthly payment would only cover the interest:
200,000×5%/12=$833.33
At the end of the 25-year term, the $200,000 principal still needs to be repaid.
Key Consideration: Interest-only mortgages are riskier and are usually suited for investors or people with a clear plan to repay the principal.
Final Thoughts
Choosing the right mortgage depends on your financial situation, risk tolerance, and long-term goals. Repayment mortgages offer security and gradual equity building, while interest-only mortgages can be useful for strategic financial planning—but they come with higher risk.
Understanding how interest and repayment work helps you make informed decisions and avoid surprises, ensuring your mortgage supports your homeownership journey rather than becoming a financial burden.