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Repayment Mortgages Vs Interest Only Mortgages
By James Miller
In one form or another, borrowing plays some part in most
people�s lives, whether it is a morgage
to buy a home or credit cards as a convenient way to shop.
Borrowing enables you to bring forward the time at which a
financial target can be met and is worth considering if
there is not enough time available to use the savings
route or if the cost of borrowing is lower than the return
you would get on saving.
Few people can afford to buy a home outright, and it would
be totally impractical to save up the full cost of your
home before you bought it; after all, you need somewhere
to live in the meantime. Therefore, the usual practice is
to take out a morgage a loan
secured against the property you are buying. This practice
has been encouraged by past governments through the giving
of tax relief on the interest paid on a
morgage to buy your only or
main home. However, this tax incentive was abolished from
6th April 2000 onwards (except for some
morgages linked to home income
plans). Without any tax incentive, it makes sense to pay
off your mortgage as soon as you can - in contrast
to the position in earlier years. The removal of the
incentive has had a dramatic impact on the types of
morgage which are suitable for
most people. In particular, endowment mortgages -
which were a popular choice in the past - should now have
no place in the financial plan of most people choosing a
mortgage for the first time. And, for many people, some
form of flexible morgage
will often be a good choice.
There is a wide range of mortgages to choose from,
though they fall into two main groups:
�Repayment mortgages, where you gradually pay off
the amount you have borrowed over the term of the loan,
together with interest
�Interest-only mortgages, where you pay only the
interest on the loan during its term. Usually, you
simultaneously make other arrangements for paying back the
capital at the end of the term. In the past, the most
common type of interest-only mortgage was the
endowment mortgage.
If you were moving home today, which type of mortgage
would you end up choosing? Back at their peak in 1988,
more than 80 per cent of mortgage customers were choosing
endowment mortgages. This is despite the fact that
endowment mortgages had by then lost most of the
advantages which made them a good buy back in the early
1980s. However, a consistent bad press and warnings from
the financial regulators about the unsuitability of modern
endowment mortgages for most people has finally taken
effect. By 2003, only 3 per cent of new mortgages
were endowment mortgages. Far and away the most
popular type of mortgage taken out nowadays is the
repayment mortgage.
Repayment mortgage
This is the most straightforward type of mortgage.
Your monthly payments pay off both interest and capital,
which, provided you keep up the payments, ensures that the
whole loan is paid off by the end of the term.
A further advantage of repayment mortgages it that
they are very flexible and can easily be adapted if you
run into temporary difficulties in making the repayments.
For example, the most common mortgage term is 25 years at
the outset, but, if you ran into problems, your lender
might agree to extend the term. This would have the effect
of reducing the monthly payments, making them more
manageable. Another option might be to add arrears to the
amount of the loan outstanding and then adjust the monthly
payments, so that the arrears as well as the original loan
are repaid by the end of the term.
The way these repayment mortgage are structured means that
your payments in the early years are almost completely
devoted to paying interest, and very little goes towards
reducing the outstanding loan. Critics point out that a
move in the early years of the mortgage leaves you
back to square one with no reduction in the amount you
need to borrow.
A point also to bear in mind is that, unlike some other
types of mortgage, there is not built-in life cover to pay
off mortgages in the event of your death. If you
have dependants, you will need to arrange separate life
insurance, though this is easily done through a relatively
cheap mortgage protection policy (a type of
decreasing term insurance).
Two factors stand out to make repayment mortgages a
good choice for many people. The first is their low risk.
If on a one-to-ten scale (one being the lowest risk and
ten being the highest) you feel most comfortable with a
risk of, say, four or les, a repayment mortgage
would be most suitable for you. The second factor is the
flexibility. In the current climate of unstable work
patterns and no tax incentives for mortgages, it makes
sense to have the flexibility both to cope with possible
hiccups in your earnings and to pay off you mortgage
early if you can. You can build in even more flexibility
by opting for a specially designed flexible mortgage.
Interest-only mortgages
These are the alternative to a repayment mortgage.
You do not pay off the loan during the mortgage term.
Instead, you pay just the interest and, in most cases,
simultaneously pay into an investment to build up a lump
sum which you will use to pay off the mortgage at
the end of the term. The investment might be an endowment
policy, ISAs (or, before April 1999, PEPs), a pension
scheme, or indeed any other investment.
In effect, you are gambling that you can use the money you
would otherwise have paid back to invest for a profit over
and above the cost of borrowing that money. If your gamble
pays off, you will either have an extra lump sum for your
own use at the end of the mortgage term of you will
have saved money during the mortgage term by paying
out less each month than you would have paid for a
repayment mortgage. If the gamble does not pay off, you
either face a shortfall when you come to pay off your
mortgage or you have to pay more over the mortgage
term than you would have done with a repayment mortgage.
In the past, there were some good reasons why this gamble
was likely to pay off. There are now some equally good
reasons why the gamble may not work:
�Tax relief on your investment Up to 1984, if you took out
an endowment In effect, you are gambling that you can use
the money you would otherwise have paid back to invest for
a profit over and above the cost of borrowing that money.
If your gamble pays off, you will either have an extra
lump sum for your own use at the end of the mortgage
term of you will have saved money during the mortgage
term by paying out less each month than you would have
paid for a repayment mortgage. If the gamble does
not pay off, you either face a shortfall when you come to
pay off your mortgage or you have to pay more over
the mortgage term than you would have done with a
repayment mortgage., you got tax relief (called
�life insurance premium relief�) on the amount you paid
into an endowment policy. This was abolished for new or
altered policies from 1984. Now, only a pension In effect,
you are gambling that you can use the money you would
otherwise have paid back to invest for a profit over and
above the cost of borrowing that money. If your gamble
pays off, you will either have an extra lump sum for your
own use at the end of the mortgage term of you will
have saved money during the mortgage term by paying
out less each month than you would have paid for a
repayment mortgage. If the gamble does not pay off,
you either face a shortfall when you come to pay off your
mortgage or you have to pay more over the
mortgage term than you would have done with a
repayment mortgage. offer you tax relief on the
amount you pay each month in savings to repay the In
effect, you are gambling that you can use the money you
would otherwise have paid back to invest for a profit over
and above the cost of borrowing that money. If your gamble
pays off, you will either have an extra lump sum for your
own use at the end of the mortgage term of you will
have saved money during the mortgage term by paying
out less each month than you would have paid for a
repayment mortgage. If the gamble does not pay off,
you either face a shortfall when you come to pay off your
mortgage or you have to pay more over the
mortgage term than you would have done with a
repayment mortgage..
�Tax relief on the In effect, you are gambling that you
can use the money you would otherwise have paid back to
invest for a profit over and above the cost of borrowing
that money. If your gamble pays off, you will either have
an extra lump sum for your own use at the end of the
mortgage term of you will have saved money during the
mortgage term by paying out less each month than
you would have paid for a repayment mortgage. If the
gamble does not pay off, you either face a shortfall when
you come to pay off your mortgage or you have to
pay more over the mortgage term than you would have
done with a repayment mortgage. Up to April 1991,
you got relief at your highest rate of tax on interest on
up to �30,000 of a loan to buy your only or main home. In
April 2000, tax relief was abolished altogether. This
makes borrowing much more expensive and reduces the
likelihood that you will be able to invest the borrowed
money at a profit.
So, although people who have had endowment In effect, you
are gambling that you can use the money you would
otherwise have paid back to invest for a profit over and
above the cost of borrowing that money. If your gamble
pays off, you will either have an extra lump sum for your
own use at the end of the mortgage term of you will
have saved money during the mortgage term by paying
out less each month than you would have paid for a
repayment mortgage. If the gamble does not pay off,
you either face a shortfall when you come to pay off your
mortgage or you have to pay more over the
mortgage term than you would have done with a
repayment mortgages. in the past may tell you that
in their experience they are a great deal, be aware that
today�s endowment In effect, you are gambling that you can
use the money you would otherwise have paid back to invest
for a profit over and above the cost of borrowing that
money. If your gamble pays off, you will either have an
extra lump sum for your own use at the end of the
mortgage term of you will have saved money during the
mortgage term by paying out less each month than
you would have paid for a repayment mortgage. If
the gamble does not pay off, you either face a shortfall
when you come to pay off your mortgage or you have
to pay more over the mortgage term than you would
have done with a repayment mortgage. is a very
different product. Some interest-only mortgages - such as
ISA mortgages do still have tax benefits
which might make them worth the gamble, but endowment In
effect, you are gambling that you can use the money you
would otherwise have paid back to invest for a profit over
and above the cost of borrowing that money. If your gamble
pays off, you will either have an extra lump sum for your
own use at the end of the mortgage term of you will
have saved money during the mortgage term by paying
out less each month than you would have paid for a
repayment mortgage. If the gamble does not pay off,
you either face a shortfall when you come to pay off your
mortgage or you have to pay more over the
mortgage term than you would have done with a
repayment mortgages do not have that advantage
mortgage
Article Source:
http://www.articlemap.com
More information :
www.mortgage-mortgages-uk.co.uk
www.auctionyourmortgage.co.uk
www.loan-4-home.co.uk James
Miller is a freelance writer specialised in consumer
credit, covering topics such as how to deal with bad
credit, mortgages and insurance. He aims to help
people navigate the financial industry.
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