Mortgages For Everyone - Page 2

Interest Only Mortgage

With an interest only mortgage, your monthly payments to the lender only go towards the interest. The actual mortgage balance - the amount borrowed - does not reduce.

That means you must repay the mortgage balance at the end of the mortgage term. To do this, you put money into a separate investment. All being well, this should grow and enable you to pay off the mortgage when required to do so.

Of course, that is the ideal situation. There are, however, no guarantees. All investments carry a risk and there is the possibility that you will not have accumulated sufficient capital by the end of the mortgage term to pay off your debt.

Typical investment vehicles to accompany an interest only mortgage used to repay the loan are :

Endowments - now virtually obsolete (largely due to negative feedback in the press and poor investment returns), although a great many people still have endowment policies linked to their existing mortgages. It is possible, however, that the investment will not grow sufficiently over the term to pay off the mortgage in full; whether it does or not is dependent upon stock market returns. Be aware of this as you will still be liable to make up for any shortfall.

ISA's - Like an endowment mortgage, an ISA mortgage combines a loan and an investment, in this case an ISA (Individual Savings Account). ISAs are a way of saving tax free and were introduced by the government to replace PEPs and TESSAs.

There are two classes of ISA available - a maxi ISA and a mini ISA - and you are currently allowed to save up to £7000 in any tax year. In any one tax year you are allowed either one maxi ISA or up to three mini ISAs.

An ISA may be a stocks and shares, cash or life insurance investment. Maxi ISAs are typically stocks and shares investments, which is why they are commonly used to support mortgages.

Not only is an ISA mortgage tax efficient, it is also flexible as you can stop and start payments to your ISA as and when you like. Nevertheless, it is an investment and brings with it the risk that it may not grow sufficiently to pay off of the loan amount in full at the end of the term.

Pensions - A pension mortgage is another investment mortgage. Each month you pay interest to your lender, while the actual loan remains the same. The loan is repaid at the end of the term from the tax-free lump sum that both private and company pensions provide on retirement.

While tax efficient, a pension mortgage is not flexible. Pension rules state that you can not touch your funds until you reach 50 - so that means you are unable to repay your mortgage before then.

There are other risks that you should also consider. A pension is intended to finance your retirement. By using part of your lump sum to pay your mortgage, you are reducing the funds available to you to live off later. You should also ask yourself how you would pay for your mortgage if you became unemployed and, consequently, unable to pay into a pension.

As well as the above, it shouldn't be forgotten that a pension fund is just another form of investment, so there is no guarantee that the tax free lump sum will be sufficient to repay the loan.

Repayment Mortgage

Repayment mortgages are ideal if you want the reassurance that, at the end of the loan period, your debt to the mortgage lender will be repaid in full. This type of mortgage is in contrast to an interest-only mortgage where there is no such guarantee.

The way a repayment mortgage works is pretty simple. Each monthly instalment pays off both the capital (i.e. the money borrowed) and the interest charged on the amount outstanding. That's why you may hear this referred to as a capital and interest mortgage.

Because you are paying off both the capital and interest with each payment, the amount you give to your lender each month is typically more than it would be if you had an interest-only mortgage. But, with a repayment mortgage, there is no need to also put money into a separate investment vehicle.