Types of Mortgage

There are basically two different types of mortgage:

Repayment, (capital and interest mortgage)

Interest only, (a savings plan repays the mortgage)

Repayment Mortgages

Your monthly repayments consist partly of the original capital amount borrowed and partly of interest at the prevailing rate, so that the amount outstanding gradually decreases throughout the term until it is fully repaid.

The main advantage of the repayment mortgage is that at the end of the term, you can be sure that the total amount of the debt has been repaid. Also over-payments and lump sum repayments into your mortgage account can be made reducing both the interest and capital amounts repayable. Although life assurance cover is not compulsory in taking out this type of mortgage you should bear in mind that if you have no life 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 outstanding balance of the mortgage.

In the early years of a repayment mortgage the majority of the monthly repayment is interest rather than capital.

Interest only

With this type of mortgage, only the interest is paid off with each mortgage payment, so the original amount borrowed is still outstanding at the end of the term. The borrower also usually takes out an alternative method of paying off the mortgage such as an ISA, pension plan or other savings plan which with a bit of luck will provide a lump sum at maturity sufficient to repay the mortgage. Endowment policies were popular a few years ago, these provided life cover and a lump sum to repay the mortgage; but they are now seldom used.

It is important to remember to regularly monitor the performance of the alternative repayment vehicle and that the payments are maintained, otherwise it will not be possible to pay off the mortgage at the end of the term. The borrower is liable for any shortfall on the mortgage so if the proceeds of the repayment vehicle do not achieve the amount expected the outstanding balance will need to be paid off from other resources.

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