Repayment and Interest-Only Mortgages
Choosing the right mortgage for your needs is vital. Select the wrong one and you could end up with monthly repayments beyond your means, or find maybe you could be paying off your mortgage quicker if you have room to move financially each month.
Changing from one to another isn’t so hard, but there’s always a cost involved. So it’s best to get it right from the outset.
Repayment mortgages and interest-only mortgages tend to be the two most popular options on the market today.
What is a Repayment Mortgage?Also know as capital and interest mortgages, this is the term for the original and most traditional type of mortgage, and is still the only way you can guarantee that your property will definitely be yours at the end of the mortgage term. Assuming you keep up the payments of course.
When you borrow money, the loan is divided into two payments. Firstly there are the interest payments. This refers to the amount of interest charged for the loan, and is worked out as a monthly sum over the mortgage term. And secondly there are the capital repayments, which is the bit over and above the interest that actually chips away at the money you borrowed, the mortgage total.
Normally, you pay off mostly interest in the early years, and gradually start to work off the capital as time goes by. Payments will be higher than interest-only, but this is because you’re paying money towards both the interest and the loan total.
First time buyers are often offered low start repayment mortgages, where they pay only interest for the early part, and gradually increase to start capital payments. Ultimately this means paying more over the term of the mortgage, but can ease the pressure of having to make high payments during the early period.
So as you are paying off both the interest you owe, and reducing the capital lump as well, this means that the interest will gradually reduce as time passes.
Beware though, as tax relief only applies to interest! As the interest decreases, so will your tax relief.
What is an Interest-Only Mortgage?The clue is in the title. When you borrow money for a mortgage, the lender will offer you a rate of interest over the loan term. This can be a fixed rate, agreed at the time of borrowing, or a variable rate of interest, led by the Bank of England base rate.
The interest-only mortgage is a way of taking the mortgage and keeping monthly repayments low. It simply pays off the interest, and the downside is that the capital is untouched. Unless you make any repayments towards the capital, at the end of the term you still owe the amount borrowed in the first place. You could lose your home if you don’t have a way of repaying the loan at the end.
Interest-only can be a good starting point for first time buyers as it keeps the monthly repayments down, but long term it is inadvisable. Most borrowers move into a repayment scheme a bit further down the line.
There are other ways of trying to ensure that the mortgage can be cleared at maturity though, such as having some other kind of investment arrangement or policy running alongside the mortgage, like an endowment or other savings plan. But there are risks involved in these solutions too, as no investment is truly safe.