Interest Only vs Repayment Mortgages:
This section will give you an introduction to mortgage repayment types and how they work.
It includes an explanation of what mortgages are and the different ways in which they can be established and repaid, depending on your own views, needs and circumstances.
1. Loans Secured on Property - Mortgagee and Mortgagor
A mortgage is the term for using property as security for money borrowed. You still own the house but you have allowed a legal restriction or interest to be placed on it.
The person borrowing the money is known as the 'mortgagor' ('debtor' in Scotland) and the person lending the money is known as the 'mortgagee' ('creditor' in Scotland).
For the majority of people, purchasing a home is the largest expense they will ever undertake and not many of us could afford to buy it outright with cash.
Demand for mortgages
House prices have risen dramatically over the past few years and the need for mortgages has therefore increased. There has also been a vast expansion in the number of mortgage lenders and the types of products they offer. This gives you, as a borrower, choice and competitive products.
If you want to purchase a home by using a mortgage, mortgage lending companies may ask you to find a certain amount of the property purchase price yourself, such as 5% or 10%. This is known as a deposit and they will lend you the rest of the purchase price over a number of years.
Once you have your mortgage arranged you can buy your property with the money. You will make payments to your mortgage lender on a regular basis and the amount they lent you will be secured on the property you buy.
Mortgages are loans secured on property. The loan is secured on the property you buy because the amount borrowed is usually substantial. This means that the mortgage lender is taking a considerable risk that you will pay back the money you borrowed.
If you do not make your required mortgage payments, because the mortgage is secured on the property, the lender has the right to take possession of it from you and sell it in order to try and recover the amount you borrowed.
2. Interest Only Basis
When you make a payment to the mortgage lender under this type of mortgage your repayments are only made up of the interest due on the lump sum you borrowed. You pay back the interest throughout the term of the mortgage and at the end of the term you have to pay back the capital you borrowed as a lump sum.
To do this, most people need a long term savings or investment plan.
The most common types of vehicles used in connection with mortgages have been endowment plans, pensions, Individual Savings Accounts and Personal Equity Plans. Each of these can be set up with the idea of long term growth and can actually be targeted on the amount you need to have at the end of the mortgage term.
By looking at the amount you need at the end of the mortgage term regular premiums can be worked out for you, based on assumed rates of growth, after any charges have been made on the policy. If the assumed rate of growth is achieved over the mortgage period then you will have the lump sum you need.
However, if the growth rate is not achieved the lump sum will be less. Likewise, if the growth rate is exceeded, the lump sum will be more than you need.
The lump sum used to repay your mortgage will usually be free of tax.
Interest only mortgages are higher risk, please read the section on endowment mortgages.
3. Capital and Interest Repayment
Each time you make a payment to your mortgage lender you will be repaying some of the capital you borrowed and some of the interest due on that capital.
With this type of mortgage, as long as you have made the correct repayments throughout the whole term of the mortgage, the balance outstanding at the end of the term will be zero.
If you choose this type of repayment method, you should also consider at least some basic form of life insurance. Many people do not take out any insurance and are unaware of the consequences of dying with a mortgage outstanding.
Protecting the mortgage borrowers with insurance can generally be done easily and cheaply and there are various types of decreasing life insurance to choose from.
4. Making Mortgage Payments
Once you have agreed the amount of money to borrow to purchase your home, you will need to decide how the money will be repaid over the years.
There are two ways in which this can happen:
5. Interest Only versus Repayment
They are very different ways of repaying a mortgage and you should think carefully about which one to choose.
Your personal life could affect which mortgage is better speak to us and pick the right mortgage to save you money.
It is a good idea to get a quotation based on both options and consider the right one for you.
The advantages and disadvantages of interest only mortgages:
The advantages and disadvantages of capital and interest, repayment mortgages:
If you need to know that your mortgage will be repaid at the end of the term you may be more likely to opt for a capital and interest repayment mortgage. Remember that the balance at the end will only be zero if you have made payments on time and at the correct amount. This way, repayment of the mortgage does not rely on financial products.
If you like the idea of just repaying interest and then the lump sum of capital at the end of the term, an interest only mortgage could be suitable. It is important to understand the unknown element of an interest only mortgage because what you get back at the end from your savings or investments may not be enough to repay the amount you borrowed. On the other hand, you may have more than enough to repay the mortgage.