Whilst most people appreciate that when borrowing money there is a need to repay it, in this day and age with interest only mortgage abound the ultimate goal of actually repaying the mortgage can be sometimes lost. In this article we discuss the ways mortgages can be set up and the overall need to ensure that some way repayment needs to be a priority.
To understand this basic principle you need to first understand how mortgages can be set up. Excluding the many types of interest deals you can get on the market there are essentially two types of mortgages, capital repayment and interest only.
Capital repayment is simple, with every mortgage you are charged interest this is the same whether you have repayment or interest only. The difference is with repayment you pay the interest which is due and you also pay a small portion of the capital. So every month the overall size of the debt reduces however small it may be. But this constant chipping away at the debt means that after the 25 years, assuming it is a 25 year term, the debt is fully repaid.
With an interest only mortgage it is only the interest on the loan that is being covered every month, the loan itself remains the same. In order to reduce the loan other methods of payment must be considered. One option is to arrange for a repayment vehicle.
A very common repayment vehicle used for many years but less nowadays is known as an endowment. A mortgage endowment is a life insurance policy for the whole size of the mortgage that also builds up a cash value through contributions and effective investment returns. The theory behind this plan is over the term of the mortgage the size of the endowment plan builds up a sufficient cash value to meet the size of the mortgage at this point it can be cashed in to repay the debt in full.
What needs to be taken into account with an interest only mortgage is that you only need to accrue enough cash to pay off the original loan and there are other methods besides endowment for achieving this goal. One such method is to take out a pension policy. As well as yielding a pension at the end of the term there will be money left over that could be used as your repayment vehicle. You will need to be sure however that when the policy matures there is enough tax free money to both pay off your debt and give a pension payout that you can live on. Pension link plans are also beneficial because of the tax savings made.
Savings plans, personal equity plans and even personal savings accounts can all be used as repayment vehicles now. But in honesty any type of savings plan, including unit trusts and bonds, can be used as long as they create a sufficient lump sum. However, with that, it must be remembered that with any sort of investment plan you are always at risk if it doesn’t produce the returns you were hoping for.
So in conclusion there are repayment mortgages and there are interest only mortgages but with interest only you have the added responsibility of ensuring you have a suitable repayment vehicle. It is always recommended that anyone getting a mortgage should seek professional mortgage advice whether it is for repayment or interest only mortgages but that advice is far more necessary if you are considering interest only with a repayment vehicle because the risks associated with getting this choice wrong can cost many thousands of pounds.