3.
Choosing the most suitable repayment method
Once you have decided on the best
interest rate structure you will need to think about how you wish to
structure the repayment of the capital debt. Do you wish to take out
a conventional repayment mortgage, or back your mortgage with an ISA
or endowment policy or pension plan? Alternatively you may wish to
simply pay the lender the interest on the loan with a view to
repaying the debt at some time in the future either from your own
resources or maybe from the sale of the property. Let's now look at
the various repayment options and what each one means in detail.
Repayment
Mortgage
A repayment mortgage is a
straightforward capital and interest mortgage where each month you
pay the agreed interest in addition to a portion of the capital that
you have borrowed. Mortgages of this nature are arranged over a set
number of years (normally up to 25) and at the end of the mortgage
term, all the interest and the capital has been repaid. The
advantage of this type of mortgage is that it is simple and
guarantees that, providing all the correct repayments are made on
their due dates, the mortgage will be paid off, in full, at the end
of the agreed term.
The main disadvantage of this type of arrangement relates to the way
that the interest is calculated and collected. In the early years of
your mortgage the majority of your monthly payment will represent
the interest being charged with only a small part going towards a
reduction in the outstanding debt. This means that the amount you
owe reduces very slowly in the early years with the majority of the
capital being repaid in the last few years. On a 25 years mortgage
it would not be uncommon to still owe over 50% of the original debt
after the first 15 years. The disadvantage of this is simple and
obvious, if you wish to repay the mortgage early, the amount by
which you have reduced the debt will be significantly less in the
early years than the later years.
This type of mortgage is, nevertheless, very flexible and does allow
you to increase your repayments at any time with a view to
shortening your mortgage term (this may not apply if you are
restrained by a fixed or discounted rate as the lender may then
impose penalties. If you think you may wish to do this at some stage
then you should check out your particular lenders policy on this
before committing yourself). With this type of mortgage life
assurance is not included and will have to be taken out separately
if required.
Interest
Only Mortgage
Interest only mortgages are becoming
increasingly popular as people wish to take more control over their
financial affairs and have more flexibility.
An interest only mortgage is exactly what it says. You will pay to
the lender only the interest on the loan for a set period of time
(again normally up to 25 years). At the end of this period of time
the lender has the right to call in the loan and you will be
expected to be able to repay the capital borrowed. To do this it is
usually necessary to run some kind of investment plan alongside the
mortgage with a view to building a cash lump sum which is sufficient
to repay the mortgage debt at the end of the term. There are a
number of ways in which people do this and these include endowment
policies, ISA's and pension plans.
If you are considering an interest only mortgage then it is
important that you take the right professional advice and we would
strongly recommend that you talk with an Independent Financial
Adviser who can examine all the options with you and explain any
pitfalls.
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