Repayment mortgage
A repayment mortgage guarantees your loan is paid off in full at the end of the agreed term, provided you make all your repayments on time.
With a repayment mortgage you make monthly payments that cover both the interest on the loan and the repayment of the loan itself.
This brings the peace of mind of knowing that you are reducing your debt every month.
A repayment mortgage offers the reassurance that once the final payment has been made you will have paid off the mortgage in full (providing all the repayments have been made).
With a repayment mortgage your monthly payments are initially comprised of mostly interest, as you make more repayments the capital is gradually reduced and the monthly payments are made up of less interest and more capital. For this reason the loan balance reduces quicker in the later stages of the mortgage term.
Interest-Only mortgage
With an interest-only mortgage you only pay-off the interest on the loan and none of the outstanding debt until the end of the term. This means that your monthly payments to the lender will be lower, but it is important that you have a strategy to repay the loan at the end of the term. This could be one of the following:
- A ‘repayment vehicle’ typically an endowment policy, ISA savings account, unit trusts or even a buy-to-let property. If your investment performs well you could have a surplus some of money at the end of the term, however if it under-performs this could lead to a shortfall.
- Converting to capital and interest. In order to lower their initial payments some people opt to take out an interest only mortgage with the intention of changing this to a repayment deal at a later stage, perhaps because they expect their income to rise. This can be a risky approach and will lead to more interest being paid, but properly managed could be a logical approach in the right circumstances.
- Making lump sum overpayments. If your income is made up of a basic salary and a large annual bonus, you may decide to take an interest only mortgage and repay lump sums to reduce the capital. If you do this it is important to have a product which would not charge fees to make these repayments. Your mortgage adviser would ensure this was the case.
Although the prospect of lower monthly payments may be attractive, Interest-only mortgages are inherently more risky. There is no guarantee that the investment plan you choose will perform well enough to pay off the outstanding debt at the end of the mortgage term. Also because the amount on which you are charged interest does not reduce, you will pay more in interest than with a repayment mortgage.
Combined/Split repayment mortgage
With a combined or split repayment mortgage a proportion of the loan is taken on an interest only basis and the remainder on repayment. Therefore, you will use both repayment and interest-only methods to repay the loan.
If you have an existing investment policy in place before seeking a mortgage you may want to consider this option, we can tailor our recommendation to your needs.
This type of mortgage is most common with people who already have an investment product (an endowment, ISA or pension plan) arranged prior to taking out the mortgage and want to use this to help reduce the additional cost of taking out the mortgage.
It is possible to use an investment policy to repay part of the loan, and then pay the remaining part with a repayment mortgage. For example, if you want to take out a new mortgage of £400,000 and you have a pension in place which will pay out a lump-sum of £100,000 and ISAs which will be worth £50,000 then you could take the remaining £250,000 as a repayment mortgage.