Basic guide to mortgages
It’s all rather confusing isn’t it? With all the talk of recession, crashing house markets and interest rates, if you’re new to mortgages how do you know what’s what? Here we’ve outlined just the basics around mortgages and some of the pro’s and con’s.
Mortgage type 1- repayment
With a repayment mortgage, the monthly payments are made up of interest AND a portion of the capital debt (i.e. how much you actually borrowed)
This means that, provided you keep them up to the end of the mortgage term (usually 25 years), you are guaranteed to clear what you owe. This is the more established type of mortgage and remains the only way the property is actually guaranteed to be yours at the end of the mortgage term- provided you have repaid the loan.
You usually pay off mostly interest in the early years and then gradually more of the main chunk you borrowed.
Mortgage type 2 - interest-only
As the name suggests, with an interest-only mortgage, the monthly payment includes only this part of the debt, not the capital or bulk amount you borrowed. The main benefit of this is that the monthly cost is considerably lower than for a repayment mortgage. The disadvantage is that at the end of the mortgage term you still owe the original amount you borrowed.
And, if for any reason you can't repay it, your mortgage lender is perfectly entitled to repossess your home. Unless you can be certain of a sizeable inheritance or other windfall, this means saving as you go along. There are several ways to do this
How do you repay capital debt if you have an interest only mortgage?
• An Isa: Isa stands for individual savings account and this is a type of tax-free investment. It's generally considered to be the best repayment option.
• An endowment: This is a stock market-based investment plan. These are now acknowledged to be very risky and, therefore, should be avoided.
• A pension plan: It's also technically possible to use cash from a pension plan to clear the debt, but this is also a very bad idea. We all know how some of those pension plans turned out!
Get advice!
Whatever method of payment you are considering it will involve making a substantial, long-term financial commitment. This is why it is vital to discuss your options with an independent financial adviser who specialises in investment before making your choice. Generally, these sessions are free as the advisor gets compensated by the companies offering you the ‘products’ you end up using for repayment. Even if the consultation isn’t free it’s a small but very worthy investment to ensure you know what you are doing in the longer term.
Be aware!
Opting for an interest-only mortgage involves accepting a significant degree of risk.
If your repayment vehicle doesn't perform well, you could be left without enough cash to clear your debt. Also, with an interest only because you are borrowing the entire sum of capital for longer, you pay the interest for longer!
The scary thing is that the majority of mortgage providers no longer ask for proof that you have set up a suitable savings or investment plan before agreeing to an interest-only mortgage. This is kind of like the credit card situation where no one asks for your credit rating or how you plan to pay them off each month and look at the mess that has caused for some people!
In a nutshell?
If you can afford it, it is safer and cheaper in the long-run to go for the repayment option. If you really need to keep your costs down for a few years, consider an interest-only loan. Take professional advice before making any decisions!
The author is a specialist in
conveyancing solicitors,
house removals and
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