Understanding your Mortgage Options: Repayment or Interest-Only
Mortgages are highly complex, and there are literally thousands of options available. In order to understand which mortgage type is best for your circumstances there are a few basics it is important to understand.
A mortgage consists of the original amount borrowed – called the capital, and the interest incurred on borrowing the capital. The capital is repaid in one of two ways; either in monthly installments, called a repayment mortgage, or as a lump sum at the end of the mortgage term, called an interest-only mortgage.
Repayment mortgage
A Repayment mortgage is a standard borrowing agreement that ensures that at the end of the agreed loan period, your debts have been repaid in full and you are the full owner of the property. Repayments on a repayment mortgage are usually made monthly, and the repayments pay off both the capital and the interest outstanding on the loan.
Advantages of a repayment mortgage include:
Disadvantages of a repayment mortgage include:
What to watch for with a repayment mortgage:
At first your repayments will be mostly paying off the interest, but gradually your repayments will go towards paying off more and more of the capital. As a result, if you resell your property early in the mortgage term you will not have repaid much of the capital and so will not see a huge return on investment unless the value of the property has risen.
Interest-only mortgage
Interest only mortgages are borrowing agreements where the monthly repayments are paid towards reducing the interest outstanding, not the capital. Instead of repaying the capital gradually, monies are invested on a monthly basis into ventures that should yield a return large enough to cover the capital by the end of the mortgage term.
Advantages of an interest-only mortgage include:
Disadvantages of an interest-only mortgage include:
What to watch for with an interest-only mortgage:
When used carefully, an interest-only mortgage can be highly successful. However, you should always seek independent financial advice from a qualified expert regarding your best investment venture.
There has also been a rise in borrowers relying solely on the property itself as the investment scheme, depending on rising house prices inflating enough to cover the capital on resale of the property. This is a highly risky venture, and one that is not recommended.
Endowment policy mortgage
A type of interest-only mortgage, an endowment policy mortgage consists of two simultaneous regular payments, one to the lender in order to reduce interest outstanding on the capital as in a traditional interest-only mortgage, and one into an endowment policy. An endowment policy is an investment account that accumulates funds to pay off the capital at the end of the mortgage term, and also serves as life assurance, in that it will cover the outstanding mortgage in the event of your death before the end of the mortgage term.
Advantages of an endowment policy mortgage include:
Disadvantages of an endowment policy mortgage include:
Endowment policies are very inflexible due to the nature of the investment. The returns on the investment can be very good, but the policy must be able to complete the agreed term; cashing your policy early, particularly early into the policy, can mean there is little likelihood of seeing return on investment; in fact it is common to receive less than invested, resulting in a loss. In the case of a poorly performing policy, the only option can be to inject more cash into the policy in the hope of avoiding a shortfall.
What to watch for with an endowment policy mortgage:
Endowment policy mortgages are not commonly recommended by many financial experts. In the last decade, press coverage of endowment policy providers misleading potential mortgage-seekers has led to a great mistrust of possible policy performance in the consumer sector. Many policy providers have been penalised for selling policies as guaranteed to repay the capital at the end of the mortgage term, and being very slow to pass on information to policy holders on badly performing investments, leaving many people vulnerable and seeking compensation.
Always seek independent financial advice if you are considering an endowment policy mortgage, or if you are considering cashing-in your policy early, rather than dealing with policy providers directly. You will be charged a fee for their impartial advice, but it could prove to be well-worth the price.
ISA mortgage
An ISA mortgage (Individual Savings Account mortgage) is a type of interest only mortgage, where monthly installments repay interest only and funds are paid into a separate account that covers the capital at the end of the mortgage term.
There are two types of ISA mortgages:
Cash ISA – money is deposited into a high-interest account on a monthly basis, where interest is earned tax-free, allowing fast growth of savings.
Equity ISA – Money is invested through a fund manager into company shares in order to yield high return to cover the capital amount at the completion of the mortgage. Equity ISAs are extremely high-risk.
What to watch for with an ISA mortgage:
In order to complete the payment of your mortgage at the end of the term you must be a highly dedicated to injecting regular funds into your chosen investment vehicle in order to have built enough to cover the mortgage at the end of the term. There are also limits on the amounts your can pay into your tax-free accounts per month, which makes them quite inflexible; if you are paying off a large mortgage this may result in a much longer mortgage term than the typical 25 years. It is very important to seek sound, independent financial advice if you are considering an ISA mortgage.
What Next?
Understanding the difference between repayment mortgage and interest-only mortgages, and which best suits your needs is important. Once you have decided how you wish to repay the capital on your mortgage, you must consider how you wish the interest on that amount to be calculated. This is the single biggest qualifying factor when it comes to considering mortgages and comparing available options. The interest payable on a set amount can vary enormously depending on the interest rate you opt for. Whether you are interested in fixed rate mortgages , variable rate mortgages , discount rate mortgages , capped rate mortgages , cash back mortgages or flexible mortgages Totally Money will take you through the mortgage maze, help you compare mortgages , and offer advice on the best options to suit your budget and requirements.
Please note: this website, and the articles and information within it are based on journalistic research. It does not and should not be construed to constitute financial advice. Any information should be considered in regard to specific circumstances. All tips are followed at your own risk and should be followed up with your own research. For more please refer to our terms and conditions of use.