With an interest-only mortgage, your monthly repayments to the lender consist only of interest on the total loan amount. The interest payments will vary depending on the interest rate being charged by the lender at the time. This type of mortgage involves paying the lowest possible monthly outlay to the lender, as no capital is included in the repayment.

Instead of repaying the capital, regular payments are put aside in a suitable investment or savings plan. This grows cumulatively and assumptions are made regarding its growth in order to calculate a monthly payment figure. If you are fortunate, the investment will accumulate at a higher rate than is required to pay back your loan on time, resulting in a cash surplus at the end of the term.

This is not always the case however, and sometimes the investment can under perform instead. This means you will have to increase or supplement your monthly payments to avoid facing a cash deficit at the end of the term. The lender will usually wish to see evidence that suitable arrangements have been made that will enable the borrower to repay the loan at the end of the term.

There are three main types of investment vehicle that a lender will usually permit to be associated with an interest-only mortgage:

• Endowment
• ISA
• Pension

It is a good idea to check your investment regularly to ensure that you are on course to generate sufficient to repay the loan at the end of the term. If your investment falls behind and it does not look like there will be enough funds on time, it may be possible to make additional contributions to get it back on track.

Some mortgage lenders do not require you to define a fixed term for repaying the loan. You either pay it back once your savings or investment scheme has accumulated enough money, or when you die, in which case the loan will usually be paid off by a separate or integrated life assurance policy, depending on the investment vehicle used. A small number of lenders also allow you to borrow money with no investment vehicle in place. This is called a standing mortgage.