Mortgages Guide | Mortgage Help Product Information

TheMoveChannel.com | Repayment Options

Introduction

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.

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.

Advantages

One of the principle advantages comes from the fact that if your investment or savings vehicle performs better than expected, then you will be left with a cash surplus at the end of the term. This can be returned as a lump sum, invested elsewhere, or stored away for some other purpose.

repayment

Interest-only mortgages allow you to amalgamate several financial needs into a single payment. For one monthly sum of money, you can cover your mortgage, life assurance, investment and protection needs. Once the initial product and provider selections are over with, some people find this all in one combination a lot easier than dealing with each product separately.

Whereas with a repayment mortgage you would have to specifically look for a mortgage that is portable if you want to take it with you when you move house, the repayment vehicle that accompanies an interest-only mortgage is always unaffected when you move home. You may need to increase the payments into the fund if you are borrowing more money to buy a more expensive house, but the term (if there is one) should be unaffected and there will be no new charges to face for setting up a new fund. This means that if you move regularly, an interest-only mortgage could see you paying off your loan earlier than a repayment mortgage.

Some buy to let investors find interest-only mortgages attractive, due to the fact that they receive tax relief on the mortgage interest payable on any investment properties they own. A repayment mortgage will therefore afford a landlord a diminishing amount of tax relief as time goes by and the debt is reduced, whereas an interest-only mortgage maximises the tax relief over the life of the mortgage.

Leaving the savings or investment product aside, the monthly payments to the lender on an interest-only mortgage are lower than with a repayment mortgage. This is particularly appealing to those who do not need to repay the capital as they go along. You may be sure you will be able to repay the loan at the end of the term, for instance with a trust fund or inheritance and therefore not want the ongoing expense of reducing the mortgage debt.

In recent years, the majority of borrowers have been scared off by the poor performance of the stock market and the poor returns it has generated for their endowment, pension or ISA fund, with the result that most people now opt for the safety of repayment mortgage. Such fears are perfectly reasonable, particularly give the publicity that has been generated by the many people that have been forced to make additional contributions to their investments or take out additional policies in order to repay their mortgage on time.

However, as long as you use fairly cautious growth assumptions for you investment and take a long-term view of the stock market prospects, some people believe that now is the perfect time to take out an interest-only mortgage. They believe that the stock market has always historically performed well on a 20-30 year basis, meaning that the markets will eventually get over their period of slow or negative growth. If this were the case and markets did indeed surge again in the future, there would be a huge amount of benefit to be had in paying as much into your ISA, endowment, or pension as possible. In the long term scheme of things you would be buying up units at a relatively low price and therefore be in a great position to benefit if or when the markets eventually pick up again. But this is of course not without its risks and not a strategy that should be adopted without sound professional financial advice.

Disadvantages

Interest-only mortgages are higher risk than repayment mortgages. With most of the investment or savings products that accompany them, there is no guarantee that your will have sufficient funds at the end of the term to repay the mortgage. Your ability to repay your debt is dependent on the investment skill of the product provider you choose, not on whether you are able to make your repayments.

Interest-only mortgages are inefficient as regards your total interest bill over the life of the loan. You pay interest on the full amount borrowed for the entire term of the mortgage, whereas with a repayment mortgage, the interest bill is reducing over time. In comparison then, you pay a considerable amount more in interest with an interest only mortgage.

If you choose an interest-only loan, you are potentially exposing yourself to what many people find are complex financial products. Understanding how they really work is not always easy and yet if you don't know the ins and outs of the products you are buying, you could be heading for disaster. If you are not clear about any aspect of a product before you buy, always seek professional advice.

Interest-only mortgages are in some ways less flexible than repayment mortgages. It is usually more difficult or more costly to switch investment products or providers during the term of the mortgage if you are unhappy with the performance of your chosen vehicle. Many of the investment products are front-loaded, which means that most of the costs and charges associated with setting up and running the product are paid for out of the premiums in the early months. It may be some time before the funds are worth as much as you have paid in, meaning that you will usually incur greater costs than you would by switching mortgage product or provider.