Mortgage
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Mortgage Types
Other Information
Repayment or Interest Only
Repayment or Interest Only?
Types of Mortgage.
Whilst there are numerous variations on a theme, with all mortgage providers attempting to convince you that their particular version is the one for you, there are, in fact, just two basic types of mortgage - we will discuss the variations of these two types a little later.
“Repayment” means that you are paying off your mortgage loan little by little every month so that, at the end of the mortgage term, you owe nothing at all. This is the only form of mortgage that guarantees that your mortgage will be paid off in full at the end of the term.
On that heady day, the house will be entirely yours and you won’t owe the mortgage lender another penny.
As you can see, this is the ideal way to pay your mortgage and you should consider interest only if you have adequate investments or a short term plan or your income is guaranteed to increase in the next few years and you can switch onto repayment.
“Interest Only” means just that – you’re only paying off the interest on your mortgage and, at the end of the mortgage term, you will owe the same amount that you borrowed all those years ago. In these difficult times, some lenders are really pulling back on interest only mortgages and will require larger deposits or that some of the mortgage is being paid off at the same time.
The advantages are that it keeps your monthly payments low but you can see the risks – can you be sure that you have plans in place to pay the mortgage off ? If you’re a savvy investor or have rental properties, then there will be clear reasons to keep to interest only payments. If not, then your broker will be sure to discuss this with you carefully.
Repayment Mortgages
This is the most common form of mortgage, particularly now that Endowment Mortgages have been so soundly discredited over the past few years. The huge advantage of a Repayment Mortgage is that it is simple, easy to understand and as risk-free as it can get. You simply repay, each month, both interest and capital for an agreed period of time. Generally, for a first mortgage this period of time will be, say, twenty or twenty-five years but is open to negotiation with your provider. Additionally, you will be required to obtain life-insurance to ensure that the mortgage is paid-off in full in the event of any borrower's death.
Initially, almost all of each repayment will be soaked up by the interest charges, with the loan seeming to hardly change for the first few years, but do not despair. The great advantage of the Repayment Mortgage is that it actually does, providing you keep up with the payments, guarantee to pay off your loan by the end of the agreed period..
The appeal of this type of mortgage is that it is easily understandable, it is not dependent upon stocks, shares or any other form of investment and it is guaranteed to pay off the loan at the end of whatever period is agreed when you buy your house.
Interest Only Mortgage
With Interest Only mortgage you will repay, just like it says, interest only throughout the life of the mortgage. This means that at the end of twenty-five years, or whatever, you will still owe the same amount as you borrowed, you will have paid off not a single penny of your mortgage. Consequently, for domestic mortgages it is normal to have another form of investment sitting alongside your mortgage which will, hopefully, build-up a capital sum to pay off your mortgage at the end of the agreed period.
Essentially, your mortgage will cost less (because you are not repaying any of the capital) but you will need to make some other provision to ensure that you have sufficient money to repay the mortgage lender at the end of the repayment term. This type of mortgage first became very, very popular in the mid-eighties, where interest only mortgages were coupled with low-cost endowment policies, the idea being that although your monthly costs were slightly higher the benefits of having an endowment policy outweighed any additional cost by a considerable margin. The argument was that the endowment policy would build up its value at such a rate that after twenty years (or whatever) your policy would not only pay off all of your mortgage but would also give you a very, very nice little nest-egg, thousands of pounds from nowhere. Great idea, but ...
These endowment policies were sold to the public at large, often by salesmen who did not really understand them, with the client being left unaware that the policy performance was entirely dependant upon stock-market performance; if the stock-market kept going up, so would the value of your endowment policy, and so it was. Policies taken out in the early eighties, maturing in, say, the year 2000 were a great investment, those taken out just a few years later were a disaster! The stock market crashed, policy values tumbled, insurance companies collapsed, policy holders could not pay off their loans. We had the first of our 'miss-selling' scandals.
At one time, interest only mortgages could be backed by all sorts of investments (endowments, PEPs, ISAs) or nothing at all but the market is a little more cautious these days, realising that umpteen years of a market going up does not mean that it cannot come down - and if it comes down at the particular moment when you need to redeem your investment that is not exactly good news!
So, interest only mortgage can reduce your monthly payments to your lender but you are not actually buying your house; you need to make other arrangements to make sure that the cash is available when needed. In the domestic market, at this moment in time, it is fair to say that that the earlier enthusiasm for interest only mortgages has waned somewhat, with the old-fashioned repayment mortgage, once again, becoming preeminent.