Mortgage Types - A Guide to UK Mortages
There are essentially two types of mortgage, Repayment (capital and interest mortgage) and Interest only (ISA, pension or endowment mortgage).
article keywords: Capital repayment mortgage, Interest only mortgages, Repayment Mortgages, Endowment Mortgages, ISA Mortgages, Pension Mortgages
- Repayment (capital and interest mortgage)
Your monthly repayments consist of repaying the capital amount borrowed together with accrued interest. On your mortgage statement, normally received annually, you will see that the amount borrowed decreases throughout the term.
- Interest only (ISA, pension or endowment mortgage)
With this type of mortgage, only the interest is paid off with each mortgage payment. The borrower also takes out at the same time, an alternative ‘repayment vehicle’ (method of paying off the mortgage) such as an ISA, pension plan or endowment policy.
The most important difference about an interest only mortgage from repayment type is that the monthly repayments do not repay any of the outstanding capital balance. As a consequence it is important that the payments are maintained into the repayment vehicle otherwise it will not be possible to pay off the mortgage at the end of the term.
Repayment Mortgages
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 of a Repayment Mortgage
- 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 stock market.
- 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 repaid 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.
- You would be unable to benefit from the stock market if it has performed well over the period of the mortgage. Therefore, there is no possibility of being able to pay off your mortgage early or receiving an additional lump sum at the end of the repayment period.
- 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.
Endowment Mortgages
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 repaid 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 of an Endowment Mortgage
- 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 of an Endowment Mortgage
- 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.
ISA Mortgages
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 stock market 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 of an ISA Mortgage
- 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, particular for higher rate taxpayers.
- An ISA can be selected to suit your circumstances and risk profile.
- 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.)
Interest Only Mortgages
Money is lent on the basis of payback to the lender with interest. However the capital lent sum, without further provision, does not reduce.
An interest only mortgage requires you to make monthly payments to the mortgage lender to cover the interest on the amount borrowed. It is necessary to establish a separate long term investment plan that will accumulate enough funds to pay off the full loan amount in your planned period of time. With an interest only mortgage there is no repayment term since the mortgage is only paid off on adequate maturity of investment plan provisions. As such the interest-only mortgage continues at whatever rate agreement has been chosen until other funds are available to pay back the borrowed capital sum.
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 of an Interest Only Mortgage
- 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.
- 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.
Pension Mortgages
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 stock market 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 of a Pension Mortgage
- Pension contributions benefit from up to 40% tax relief for higher rate tax payers.
- 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 unforseeable changes.
If you are having problems obtaining an mortgage or are have problems keeping up with payments and are in fear of repossession, then you've arrived at the right place.
Even if you have been declined a loan or refused credit elsewhere, we can help. We have vast experience in managing to stop home repossessions, even those on the very brink of personal disaster.
Bankruptcy Alternatives
Debts over £10K ? An IVA maybe the solution for you. upto 70% of all Debts written off.
Bad Credit Loans
Specialists in helping UK residents who have been refused a loan elsewhere.
See Also Abacus Debt Advice- Free Debt Advice
This material is for general information and only constitutes advice in the broadest of terms. You should not rely on this information to make any decisions. Call our advisors on 0800 043 2444 for professional advice for your own particular situation.