Types of Mortgage

There are two main types of mortgage:

1. Interest Only

With an interest only mortgage, your scheduled monthly payments constitute interest due to the lender and do not include any element of capital repayment. Your agreement with the lender will stipulate that you must repay the total capital borrowed at the end of the mortgage term.

An advantage of interest only mortgages is that should you remortgage or move home, your investment or protection policies can normally be reallocated for use in conjunction with the new mortgage. There are several different investments which can potentially be used to repay the capital with this type of mortgage and the more common vehicles are explained below.

A disadvantage to an interest only mortgage is that the debt does not reduce and it is essential to ensure that the means are in place, either in the form of private resources or a suitable investment vehicle, in order to repay the loan as a lump sum at the end of the mortgage term. If these means are not in place when repayment becomes due, your home may have to be sold in order to repay the lender.

Endowment

ISA

Pension

2. Repayment

This type of mortgage is also known as a 'capital and interest repayment mortgage'. The monthly repayments to the lender cover the interest due and an element of capital. In the early years of a repayment mortgage, most of what you pay is interest. As the loan progresses, more of your monthly payment goes toward reducing the outstanding capital.

An advantage of this type of mortgage is that you can see a reduction in the outstanding capital and, notwithstanding fluctuating property values, you may be building some potentially realisable equity in your property. A repayment mortgage will always guarantee that your loan will be repaid at the end of the term, provided you maintain your monthly payments. If you or the lender require life cover this will need to be arranged separately.

A disadvantage of this type of mortgage is that if you move home several times, it is tempting to take a 25 year mortgage on each occasion to keep the monthly repayments low, meaning that your initial 25 year commitment can last longer than the original term intended.

This is an area where most property purchasers find independent financial advice invaluable.