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Essentially, there are only two
different types of mortgage - Repayment only (capital and interest
mortgage) and Interest only (ISA, pension or endowment mortgage) |
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Repayment-Only Mortgage |
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Monthly repayments consist of repaying the capital amount borrowed
together with accrued interest. On the mortgage statement, normally
received annually, the amount borrowed decreases throughout the term.
Advantages
At the end of the term, you are safe in the knowledge that the total
amount of the debt has been repaid. Overpayments and lump sum payments
into your mortgage account can be made, reducing both the interest and
capital amounts repayable. Life assurance cover is not always necessary
in taking out this type of mortgage.
Disadvantages
There may be financial penalties for making lump sum/overpayments into
the mortgage account. In the early years of a repayment mortgage the
majority of the monthly repayment is interest rather than capital. For
borrowers moving house regularly, this can result in little of the
capital being paid off. If you have no life assurance cover in place and
die before the loan is repaid, the mortgage will still need to be
repaid. This may result in the property having to be sold to repay the
debt owed. |
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Interest-Only Mortgage |
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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 an Endowment Policy (which in the 1980’s and
1990’s were extremely popular). The most important fact about an
interest only mortgage 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.
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Endowment |
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This is the most common type of interest only mortgage which also
provides life assurance cover and a fixed payment for investment. The
fixed payments are based on the amount of the loan together with the
mortgage term and are designed so that, at maturity, the amount invested
and earnings are sufficient to pay off the mortgage. Much maligned in
the press because of the poorer investment growth rates achieved in a
low inflationary environment this form of investment is less popular
these days. Note there is no guarantee that, when the endowment matures
and ‘pays out’, the balance will be sufficient to repay the mortgage.
Nonetheless millions of borrowers have one or more endowment policy and
as a rule of thumb these should not be cashed-in early and certainly not
before seeking advice from a suitably qualified financial adviser.
Customers cashing-in an endowment policy in the first few years after
inception can receive less than the amount invested. Existing endowments
can be used to support a new mortgage with any ‘additional lending’ over
the value of the projected maturity balance being covered on a repayment
basis or with an alternative repayment vehicle eg. an ISA. It is also
worth pointing out that historically the returns on endowment policies
have been pretty good (provided they go full term). Endowments provide
life assurance so that in the event of death the mortgage is paid off.
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ISA |
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The Individual Savings Account (ISA) is a tax free method of saving.
Using an ISA as a repayment vehicle is growing in popularity but due to
the ISAs complexity it is only for the financially sophisticated or
borrowers taking advice from a suitably qualified financial adviser.
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Pension Plan |
Life assurance cover is provided and monthly payments
are made into a pension fund. When the benefits are eventually
taken, the mortgage is repaid using tax-free cash from the remainder
of the fund. The plan holder can then draw a pension from the
balance of the fund. This product, which tends to be used by the
self employed, is only for those taking advice from a suitably
qualified financial adviser.
Advantages
If the proceeds of the plans exceed the amount required to repay the
mortgage, then this is received as a cash lump sum by the borrower.
Some plans are tax-efficient.
Disadvantages
If the proceeds of the repayment vehicle do not achieve the amount
expected, then there will be a shortfall. The borrower remains
liable for any shortfall on the mortgage hence the outstanding
balance will need to be paid off from other resources. Regular
checking of the policy fund itself by the borrower and the lender
should minimise any risk. If the plan is not reaching its expected
target, the borrower can increase payments into the policy or invest
in another product to cover any anticipated shortfall. Cashing in
the plans early may result in financial penalties. These will be
provided for in the initial agreement. In addition the lender has no
way of tracking some of the more modern repayment vehicles, such as
an ISA, which will result in some instances where a borrower lets an
investment lapse forgetting or not realising it is to be used to pay
off the mortgage. This will result in situations where there is no
method of paying off the mortgage and the lender will only become
aware at the end of the mortgage term.
In most cases, a mortgage is the biggest financial transaction in
most people's lives. To help you understand a little more about
mortgages, we have included some definitions and explanations of
commonly used terms. Click on the headings on the left for more
information. [TOP]
If you need any further help or advice, please call us on 0800
0831104
or email
info@abbeyremortgages.com |
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THINK CAREFULLY BEFORE SECURING
OTHER DEBTS AGAINST YOUR HOUSE. YOUR HOME MAY BE REPOSSESSED IF YOU DO
NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE. TYPICAL APR 7.50% VARIABLE.
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