It is worth thinking about your mortgage loan even before you hit the high street or search the internet. There are only two main ways to pay off the mortgage, but they are very different in the way they work and the effect they have on your debt.
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Repayment mortgage
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- A repayment mortgage is guaranteed to pay off your mortgage by the end of the term. That makes it the safest way to repay your loan.
- It works just like a normal personal loan - each month, you pay back some of the original capital plus interest on the outstanding balance.
- In the early years, most of your repayments are made up of interest, with the result that you only pay off a small proportion of the capital. But you can pay in extra lump sums, or overpay regularly, to reduce your debt and cut the amount of interest you have to pay. Redemption penalties on some special deals may prevent you doing this, though, so check first.
- Most mortgages are paid back over a period of 25 years, but you can opt for a shorter repayment period if you can afford the higher payments.
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Repayment mortgages are good if:
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- You prefer the safety-first approach and want to be sure you will eventually pay off your mortgage.
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Interest only mortgage
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- If you opt for an interest only mortgage, your monthly payments will seem much cheaper than those for a comparable repayment loan. But that’s because you are only paying back interest - it’s up to you to come up with the cash to repay the original loan amount at the end of the mortgage term (usually 20 or 25 years).
- Most people decide to set up an investment plan to pay off the capital they owe. This can be stock market based (using an individual savings account (ISA), for example) or through an endowment policy. These are no longer popular. An estimated three-quarters of all the 9.7million endowment mortgages will be unable to pay off the home loans they are supposed to cover. This is because their performance is linked to the stock market which performed badly between 1999 and 2003.
- A few people don’t take out investments but rely on house price rises to pay off their loan when they sell up. This can be risky if you don’t have much of a deposit to put down on a property - and if prices drop instead of going up.
- You can make capital repayments with an interest only mortgage to reduce your mortgage debt faster and cut interest payments, just as you can with a repayment mortgage. But check there are no redemption penalties first.
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Interest only mortgages are good if:
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- You expect investment returns (after charges) to be higher than mortgage rates.
- You expect to earn bonuses that you can use to pay down your mortgage regularly, or inherit money that you can use to pay off your mortgage.
- You expect house prices to rise substantially so that you have enough equity in your property to pay off your loan.
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They are not so good if:
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- You don’t want to take the risk that your investment will not grow fast enough to pay off the mortgage.
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Flexible mortgage
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- Flexible mortgages are repayment mortgages that enable you to pay off your mortgage earlier and cut your interest costs.
- They offer the ability to overpay, underpay, and take payment holidays. Any overpayments you make are immediately credited against what you owe. With traditional mortgages, overpayments are usually only credited once a year, and may not be possible at all if redemption penalties apply.
- Flexible mortgages also charge interest on a daily or monthly basis, instead of the normal annual basis. This makes a big difference to the amount of interest you pay in total.
- Most flexible loans are traditional mortgages with additional flexibility. These come in the usual variety, with discounted, fixed and tracker rates available.
- Truly flexible loans are the relatively new type of current account or offset mortgage products. Both types allow you to put your mortgage, credit card, personal loan, current account and savings in one pot.
- This effectively means you earn tax-free interest on your savings as all your money is being used to offset your mortgage. And all your borrowing is also effectively at a lower rate of interest.
- The main difference between the two types of account is that the current account product puts everything in one pot, producing one statement, while offset products keep your accounts separate.
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Flexible loans are good if:
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- You expect to be able to make overpayments, either regularly or occasionally.
- You have irregular earnings that make flexibility with mortgage payments important.
- You can benefit from the tax and interest advantages of having all your money in one pot. This generally applies to high earners and people with significant savings to offset their debts.
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Flexible loans are not good if:
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- You are unlikely to use the flexibility, need to budget or want to keep your mortgage costs as low as possible. Flexible loan rates are not usually the most competitive, and you may be better off with a discounted or fixed rate mortgage in these circumstances.
- You are undisciplined with money. Current account mortgages in particular are no good for spendthrifts who cannot mentally put aside an amount to pay the mortgage each month when it does not physically disappear from their account.
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