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Different Repayment Mortgage Types
Repayment Mortgage
With a repayment mortgage, also known as a capital repayment
mortgage, you make monthly payments which contribute towards the
total amount borrowed and the interest payable. Repayment mortgages
are repaid over a specified period. Assuming you continue to make
all your monthly contributions in full, the mortgage is guaranteed
to be paid off in full at the end of the arranged mortgage term.
During the early years of the mortgage, the majority of each monthly
payment goes towards paying the interest owed. The amount paid
off each year increases as the mortgage term progresses.
Advantages
- Provided that you make all the required monthly mortgage payments,
you are guaranteed to pay off your mortgage in full by the end
of the repayment period.
- It removes the risk of having an investment, the performance
of which is dependent on the stockmarket.
- You are less likely to suffer from negative equity because
your mortgage balance will be reducing month on month.
- Assuming your property has not dropped in value, as the capital
repayed increases you will see an increase in the level of equity
in your property. Consequently, when you remortgage or move
home you may find it easier to obtain a mortgage and you may
be able to avoid paying a Mortgage Indemnity Guarantee.
Disadvantages
- You would be unable to benefit from the stockmarket if it
has performed well over the period of the mortgage.
- Because very little of the amount borrowed is paid off in
the early years of the mortgage, if you were to move again in
those early years it is likely that you would need to take out
a new 20/25 year repayment mortgage, in order to make monthly
repayment amounts manageable. i.e. the period for paying off
your debt could be extended.
Interest only
An interest only mortgage requires you to make monthly payments
to the mortgage lender in order to pay off the interest on the
amount borrowed. In addition to the interest only mortgage you
need to establish a separate long term investment plan that will
accumulate enough funds to pay off the full loan amount at the
end of the repayment period.
The investment plan required to pay off the mortgage usually comes
in one of three forms; an ISA (individual savings plan), a pension
or an endowment. This investment does not have to be provided
by the mortgage lender.
Advantages
- You can choose an 'investment vehicle' that is tax efficient.
- If the investment growth rate exceeds those estimated at outset
you may be able to pay off your mortgage early or enjoy a lump
sum at the end of the repayment period, in addition to paying
off your mortgage.
Disadvantages
- You have no guarantee that you will have sufficient funds
to pay off the mortgage at the end of the repayment period,
as the investment could perform below that assumed at the start.
(By monitoring your investment's performance you could make
additional contributions during the repayment period if you
felt the fund was under performing.)
- Some forms of investment may incur a penalty fee if you stop
paying premiums.
- Your debt remains constant throughout the mortgage period.
Flexible
Flexible mortgages allow overpayments and underpayments to be
made against your mortgage without penalty costs being incurred.
Being able to control when and how much you repay means that you
can overpay when you have spare cash. Conversely, if you find
yourself short of money you can repay less than you would normally,
skip a payment or even borrow money against the capital repaid.
However, with repayments being under your control rather than
being defined by the mortgage lender, you need to maintain discipline
when repaying a flexible mortgage. Making too many underpayments,
or skipping too many payments without readdressing the shortfall
with overpayments will result in you having to extend the period
over which you repay your mortgage. This will subsequently increase
the amount of interest you have to repay.
In light of this potential problem, it is advisable to follow
this simple rule; Overpay when you can. Underpay only when you
really need to.
Not all flexible mortgages are equal as the conditions imposed
do vary. Some restrict how much you can overpay during a specified
period by setting either a lower or upper limit on the additional
repayment amount. For example, some lenders will only allow you
to make additional payments over £1000. Some lenders will not
allow you to make an additional payment of more than £100 per
month.
Restrictions can also apply to borrowing against the capital already
repaid. In fact, some mortgages labelled as 'flexible' do not
allow you to borrow any money against your mortgage. If borrowing
is permitted you should check how easy it is to access the cash
you require. Do you need to make a formal request or are you able
to simply withdraw cash from an account?
There is a type of flexible mortgage that helps you to make even
more of your money; the 'current account mortgage'. With this
type of mortgage, you current account balance is offset against
the outstanding balance on the mortgage. For example, if you have
an outstanding mortgage balance of £50,000 and a current account
balance of £1,500, your mortgage interest will be based on an
outstanding balance of £48,500.
Even if you only ever have your monthly salary paid into your
current account, the balance of which gradually falls as the month
progresses, you can still save hundreds if not thousands of pounds
over the period of the mortgage as the outstanding balance is
calculated on a daily basis.
Some current account mortgages also allow you to combine a credit
card and loan with your mortgage and current account.
Advantages
- You can pay off your mortgage early, without penalty, by making
overpayments.
- You can borrow against mortgage overpayments or equity in
the property more easily, and at a lower interest rate than
a 'standard' loan. (dependent on the type of flexible mortgage)
- You are able to change mortgage at any time without being
penalised as there are no early redemption penalties.
- You can benefit from a fall in the Bank of England's base
rate that leads to a subsequent fall in your lender's standard
variable rate.
Disadvantages
- Making too many underpayments could result in extending the
mortgage repayment period.
- The Bank of England base rate can be unpredictable and can
increase rapidly, resulting in an increase in your monthly payments.
- It is less easy to budget as the interest rate can and will
vary.
- A fall in the base rate will not always result in an equivalent
fall in the lender's standard variable rate. (unless the flexible
mortgage offers a tracker interest repayment)
ISA Mortgage
An ISA mortgage is effectively an interest only mortgage with
an additional investment plan in the form of an individual savings
account (ISA). An ISA is a stockmarket based investment that benefits
from tax free growth.
Strictly speaking, an ISA is not an investment but a 'wrapper'
within which an investment can benefit from tax free growth. Choosing
an individual savings account is a subject in itself.
(Individual savings plans replaced personal equity plans (PEP's)
in the 1999/2000 tax-year, although PEP funds can remain invested.)
Advantages
- If the ISA performs well you may be able to pay off your mortgage
early or enjoy a lump sum at the end of the repayment period,
in addition to paying off your mortgage.
- ISAs are potentially tax efficient, particulary for higher
rate taxpayers.
- An ISA can be selected to suit your circumstances and risk
profile.
Disadvantages
- Your debt remains constant throughout the mortgage period.
- You have no guarantee that you will have sufficient funds
to pay off the mortgage at the end of the repayment period,
as the ISA could perform below expectations. (By monitoring
your ISA's performance, you could make additional contributions
during the repayment period if you felt the underlying fund
was under performing.)
Pension Mortgage
A pension mortgage is an interest only mortgage with an additional
investment plan in the form of a personal pension. A personal
pension is a stockmarket based investment that benefits from tax
relief and tax free growth.
A pension pays a tax free lump sum and a monthly taxed income
on retirement. The lump sum is normally used to pay off the mortgage.
Advantages
- Pension contributions benefit from up to 40% tax relief for
higher rate tax payers.
Disadvantages
- Your debt remains constant throughout the mortgage period.
- You have no guarantee that you will have sufficient funds
to pay off the mortgage at the end of the repayment period,
as the pension fund could perform below expectations. (By monitoring
your pension fund's performance, you could make additional contributions
during the repayment period if you felt it was under performing.)
- The lump sum cannot be used for other purposes. You therefore
need to ensure that your level of pension contributions are
sufficient enough to maintain your required standard of living
during retirement.
- The mortgage period may be longer than 25 years, depending
on your age. You will still need to meet interest rate payments
throughout this period.
- The tax situation regarding pensions is open to unforseable
changes.
Endowment Mortgage
An endowment mortgage is effectively an interest only mortgage
with an additional savings plan in the form of an endowment policy.
Monthly contributions are made to a Life Insurance Company who
invest your money in the savings plan. Life insurance is built
in to the savings plan so your mortgage is repayed if you die
before the endowment policy reaches maturity.
Endowment policies typically take two forms; 'with-profits' and
'unit-linked'.
A 'with profits endowment' has two bonuses; a reversionary bonus
and a terminal bonus. The reversionary bonus is paid each year
and is guaranteed if the policy is maintained until its maturity
date. The terminal bonus is paid on maturity of the policy and
is dependant on the performance of the underlying fund.
The value of a unit-linked policy is determined by the value of
the underlying investment at the maturity date. The value of units
on a unit-linked policy can go down as well as up.
Advantages
- If the investment growth rate exceeds those estimated at outset
you may be able to pay off your mortgage early or enjoy a lump
sum at the end of the repayment period, in addition to paying
off your mortgage.
- The life insurance cover can be cheaper than if purchased
on its own.
- The mortgage can be transferred to another property.
Disadvantages
- Endowment plan charges are relatively high.
- You have no guarantee that you will have sufficient funds
to pay off the mortgage at the end of the repayment period,
as the investment could perform below that assumed at the start.
(By monitoring your investment's performance you could make
additional contributions during the repayment period if you
felt the fund was under performing.)
- Endowment plans are less flexible than other types of investments,
with most plans not allowing you to stop and start premiums.
Some plans charge penalties if you stop paying premiums.
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