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A Guide to UK Mortgage Types

There are basically two types of mortgage: Repayment and Interest Only.

For repayment mortgages, your monthly repayments will consists of repaying the capital amount that was borrowed, alongside the accrued interest. On your mortgage statement, which you will receive once a year, the amount that you have borrowed should decrease with each term.

Then there are interest only mortgages. These types of mortgage involve just paying the interest off with each mortgage payment. At the same time, the borrower will take out an alternative “repayment vehicle,” such as an ISA, through which they will pay off the mortgage.

The main difference between the two types of mortgage is that for interest only mortgages, the monthly repayments do not repay any of the outstanding capital balance. What this means is that payments have to be maintained in to a repayment vehicle – otherwise it will be impossible to pay off the mortgage at the end of the term.

 

Repayment Mortgages

 With repayment mortgages – also known as capital repayment mortgages – the borrower makes monthly payments that contribute towards the total amount that has been borrowed as well as the interest owed. Repayment mortgages are repaid within a specific time period. As long as you maintain the schedule and make all your monthly payments in full, the mortgage is guaranteed to be paid off at the end of the previously agreed mortgage term.

During the mortgage’s early years, the vast majority of each monthly payment will go in to paying the interest that is owed. The amount that is paid off each year increases as the term of the mortgage progresses.

Advantages of a Repayment Mortgage
As long as you make all the necessary monthly mortgage payments, your mortgage will be completely paid off by the end of the repayment period.

Repayment mortgages removes the risk of having an investment whose performance depends on the whims of the stock market.

With a repayment mortgage, you are a lot less likely suffer from negative equity. This is due to the fact that one’s mortgage balance reduces from month to month.

As long as your property does not drop in value, the level of equity in your property will increase. As a result, once you remortgage or move, you will find it a lot easier to obtain a mortgage. You may even be able to avoid paying a Mortgage Indemnity Guarantee.

Disadvantages of a Repayment Mortgage
If the stock market performs well during the period of the mortgage, you will not be able to reap its benefits. Thus, there is no possibility of paying off your mortgage early.

What is more, because only a little bit is paid off in the mortgage’s early years, if you decide to move again then it is very likely you will have to take out another long term repayment mortgage just in order to make monthly repayment amounts manageable.

 

Endowment Mortgages

 An endowment mortgage is basically an interest only mortgage with an additional savings plan in the form of an endowment policy. Monthly contributions are made to a Life Insurance Company who invest your money in the savings plan. Life insurance is built in to the savings plan so your mortgage is repaid if you die before the endowment policy reaches maturity.

Advantages of an Endowment Mortgage
In the event that the investment growth rate exceeds those estimate at the outset, then you may well indeed be able to pay off your mortgage early. Alternately, you may also receive a lump sum at the end of the repayment period – in addition to paying off your mortgage on time.

What is more, the life insurance cover may be a lot cheaper when acquired on its own.

Finally, endowment mortgages are beneficial in that they can be readily transferred to another property.

Disadvantages of an Endowment Mortgage
The charges on these plans are quite high, compared to other types of mortgages.

What is more, there is no guarantee that you will have the sufficient funds to pay off the mortgage at the end of the repayment period. The investment could very well perform below the level that was assumed at the beginning.

Finally, endowment plans are a lot less flexible than other investment types. The vast majority of plans do not allow you to start and stop premiums. Some plans will also charge you penalties should you stop paying premiums.

 

ISA Mortgages

These mortgages are basically interest only mortgages with an additional investment plan that comes in the form of an individual savings account, or ISA. An individual savings account is an investment that is stock market based. It benefits from tax free growth.

To be precise, ISAs are not investments, but “wrappers” within which investments are able to benefit from tax free growth.

Advantages of an ISA Mortgage
In the event that the ISA performs well, you can pay off your mortgage early. Alternately, you may receive a lump sum at the end of your mortgage repayment period, in addition to paying off your mortgage on time.

For those tax payers who have to pay higher rates, ISAs can be quite tax efficient.

What is more, an ISA that is suited to your risk profile and financial circumstances can be readily found.

Disadvantages of an ISA Mortgage

Throughout the duration of your mortgage period, your debt will remain constant.

Furthermore, you have no guarantee that you will have sufficient money to pay off the mortgage at the end of the repayment period – this is because the ISA may very well perform below expectations.

Interest Only Mortgages

In this type of mortgage, money is lent on the basis of payback to the lender with interest. The capital lent sum does not reduce.

Interest only mortgages require you to make monthly payments to the lender in order to cover the interest on the amount you are borrowing. It is thus necessary to establish a separate long term investment plan that will accumulate enough funds to pay off the full loan amount in your planned period of time. With an interest only mortgage, there is no repayment term since the mortgage is only paid off on adequate maturity of investment plan provisions. As such, the interest only mortgage continues at whatever rate agreement has been chosen until other funds are available to pay back the borrowed capital sum. In order to pay off mortgage, usually one of three forms is used – a pension, endowment, or an individual savings plan. The investment does not have to be provided by the mortgage lender.

Advantages of an Interest Only Mortgage
It is possible to select a tax efficient investment vehicle.
What is more, if the investment growth rate exceeds those that have been estimated at the outset, you may find yourself in a position to pay off the mortgage earlier than expected. You may also enjoy a lump sum at the end of the repayment period, in addition to having the peace of mind that the mortgage has been completely paid off.
Disadvantages of an Interest Only Mortgage
There is no guarantee that you will be able to pay off the mortgage at the end of your repayment period. After all, the investment might well perform below what was assumed at the start.
Your investment might incur a penalty fee in the event that you stop paying premiums.
Your debt will remain constant throughout the mortgage period.

Pension Mortgages

A pension mortgage is an interest only mortgage with an additional investment plan in the form of a personal pension. A personal pension is a stock market based investment that benefits from tax relief and tax free growth.

A pension pays a tax free lump sum and a monthly taxed income on retirement. The lump sum is normally used to pay off the mortgage.

Advantages of a Pension Mortgage
Pension contributions benefit from up to 40% tax relief for higher rate tax payers.

Disadvantages of a Pension Mortgage
Your debt remains constant throughout the mortgage period.
You have no guarantee that you will have sufficient funds to pay off the mortgage at the end of the repayment period, as the pension fund could perform below expectations.
The lump sum cannot be used for other purposes. You therefore need to ensure that your level of pension contributions are sufficient enough to maintain your required standard of living during retirement.
The mortgage period may be longer than 25 years, depending on your age. You will still need to meet interest rate payments throughout this period.
The tax situation regarding pensions is open to unforeseeable changes.