Yes, you can pay off lump sums on an interest-only mortgage to reduce the principal balance, often through "overpayments". While interest-only payments cover only interest, most lenders allow extra, ad-hoc lump sum payments or increased monthly instalments to reduce the capital owed, though some may impose annual limits (e.g., up to 10% of the balance).
If you'd like to reduce your balance before your mortgage term comes to an end, you could make regular or lump sum overpayments. And if your initial period has ended (which could have been a fixed or tracker rate), you can overpay without paying an Early Repayment Charge.
Repayment plans
What are the disadvantages of interest-only mortgages?
You can usually make limited extra repayments on fixed-rate loans, often up to $10,000 a year, depending on the lender. The only caveat is that interest-only periods and fixed terms are independent of each other. With some lenders, it's actually possible to get a 3-year interest-only period on a 3-year fixed term.
The 3-7-3 Rule in mortgages isn't a loan type but a federal timeline from the TILA-RESPA Integrated Disclosure (TRID) rule, ensuring borrower protection by mandating disclosures within 3 business days of application, a 7-business-day wait between the initial Loan Estimate and closing, and another 3-day wait if significant changes (like APR) occur, giving borrowers time to review costs before committing to a loan.
An interest-only loan allows you to make monthly payments of only the interest for a specific period of time without the principal (although you can always make extra principal payments). The advantage of an interest-only loan is a lower payment.
Interest-only mortgages used to be easy for banks to resell to other financial institutions. That's no longer the case. Today, this loan type is seen as higher risk. As a result, mortgage lenders often charge higher interest rates than they do for fixed-rate mortgages.
An interest-only mortgage payment on $200,000 depends on the interest rate, but at 5%, it's around $833/month (just interest), significantly lower than principal & interest payments, though you never build equity and pay more total interest over time, with later payments including principal. For example, at 3.25%, the initial payment is about $542/month for the interest-only period.
Switch to a repayment mortgage
If you have sufficient time before your interest-only mortgage ends, ask your lender to switch it to a repayment mortgage. This will increase your monthly payments but endure that the balance is repaid at the end of the term.
If you're over 55, you might be able to take out equity release to pay off your interest-only mortgage. One equity release choice is a lifetime mortgage. It's a loan secured against your home that lets you access the money tied up in it, without having to move out.
If you apply for an interest only mortgage, we will work with you to agree a repayment plan to pay off the borrowed capital - your plan can also include an endowment, a pension plan, or a stocks and shares ISA. You are liable to repay all the capital borrowed, even if you fall short at the end of the term.
Overpaying your mortgage can have big benefits, including clearing your repayments sooner and paying less interest.
The option of making interest-only mortgage payments will generally last between three and 10 years. After the interest-only payment period ends, you will then have to make principal and interest payments, which means your monthly payment will increase, regardless of whether the interest rate stays the same or changes.
Disadvantages
Make extra payments toward the principal
A large part of your monthly mortgage payments goes toward the principal and interest. One way to pay off your loan faster is by making extra payments to the principal only, says Forbes.
Some lenders can extend interest-only mortgages by up to 20 years. The lender will need to assess your income, credit history, and repayment vehicle again to make sure you can make the final payment later.
Interest-only repayments
Once the agreed interest-only period ends, you'll start repaying your principal at the current interest rate at that time. As you're not making payments on the 'principal', this will remain the same, unless you choose to make additional repayments.