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Repayment or Interest Only?
One key decision you have to make on your mortgage is between a repayment and an interest only mortgage. You either pay only the interest on the money you have borrowed, or you pay the interest and a portion of the capital each month.
Repayment mortgages
- Repayment mortgages give you the most certainty that your mortgage will be paid off within a known period.
- Your monthly repayments cover both capital and interest on the loan. A lender may insist on other insurance to protect their security, normally this will only be buildings insurance but the lender may recommend life insurance as well in case you die before the mortgage is cleared.
- A repayment mortgage is simple, straightforward and easy to understand. It also avoids the risk of investing in the stock market for your repayment vehicle.
Interest only mortgages
- An interest only mortgage allows you to pay only the interest on your mortgage. Your mortgage balance will not reduce; accordingly you will normally need some other method of repaying your mortgage at the end of the term.
- To ensure you can make this final payment, you may need to invest additional funds in investments which are designed to generate enough capital to repay the loan at the end of the term. Alternatively you may decide to sell the property and downsize or move into rented accommodation in order to clear the mortgage.
- You can choose from a variety of investment vehicles, some of which can have tax advantages. Should you move or remortgage, your investment vehicle can usually be attached to the new mortgage.
- Unlike a repayment mortgage, the total amount of your debt does not reduce over time. There is no guarantee that your chosen investment vehicle will grow sufficiently to repay your loan (although you can usually top up your contributions towards investments as you go along if this looks likely to be the case)