Capital and Interest
Sometimes known as a repayment mortgage, this is where your monthly payments to the lender are made up partly of the interest on the outstanding loan and partly repayment of the loan itself.
In this way, you gradually pay off the full amount of your mortgage over the repayment period. In the early years, more interest than capital is paid, but in time this will change and towards the end of the mortgage term you will be paying mostly capital.
If you opt for capital and interest payments, you should consider a term assurance policy so that should you die or be diagnosed with a critical illness during the mortgage term, the proceeds of the policy will repay the remainder of the loan. Most borrowers opt for this type of mortgage.
With this type of mortgage your monthly payments cover only the interest on your loan, so the amount you owe does not reduce during the term of the mortgage. After 25 years paying an interest only mortgage of £100,000, you would still owe £100,000.
Repayment of the capital sum is usually funded by an investment, for example, an ISA, a personal pension plan or a life assurance policy. You could also use an inheritance, regular over-payments (where the mortgage scheme allows) or selling the property and buying a cheaper house.
It is important to remember that if you are intending to use an investment to repay the capital sum, then values can go down as well as up and cannot be guaranteed on maturity. It may therefore, not be sufficient to pay off your mortgage at the end of the term. For this reason, it should be monitored by you from time to time to check the likely maturity value and, if necessary, the monthly premiums increased to boost the final sum payable.
On the other hand, if the investment performs well, it is also possible for its value to be greater than the amount needed to repay your mortgage, in which case you will receive the surplus as a cash lump sum. Another important point to bear in mind about interest only payments is that the investments designed to repay them are invariably long-term investments. This means that it is unwise, sometimes impossible, to take the benefits before the investment has run its full term.
Please remember that if you take out an interest only mortgage, it is your responsibility to ensure that there is an adequate vehicle in place which will repay the capital sum in full at the end of the mortgage term. Without a suitable repayment option in place, you run the risk of still owing the full mortgage debt at the end of the term, creating unexpected financial worries.
As these types of mortgage can be seen as higher risk they are often more difficult to obtain and are
typically aimed at those on higher incomes or with assets to support the mortgage.
Using an individual savings account (ISA)
A mortgage linked to an ISA is very similar to one that is linked to a pension plan.
You make monthly payments of interest to the lender and regular premiums to the ISA provider to build an investment designed to repay the loan at the end of the mortgage term and hopefully provide you with a tax-free lump sum as well.
You need to remember however, that the value of an ISA and any income from it, can fall as well as rise, and returns are not guaranteed. If you are considering an ISA option, you should also consider a term assurance policy for the full amount of the loan to ensure that, in the event of your death, the mortgage will be repaid.
Sale of Mortgaged Property
Some lenders will allow the sale of the mortgaged property as a stated way of repaying an interest only mortgage. *conditions may apply