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Repaying your Mortgage

How to repay my mortgage?

 
While there are many different interest charging options, there are just two means of repayment; interest only and capital and interest (repayment)

With an interest only mortgage you pay the interest only to the lender and take out a further investment alongside which you hope will pay off the loan at the end of the term.

Mortgage lenders are fairly flexible about what investment method is used to pay off the loan and popular choices have been endowment policies, unit trusts and pensions.

With a capital and interest mortgage each payment pays both the interest and a small part of the capital. With this type of mortgage your mortgage loan will be paid off by the end of the term.

With a capital and interest (repayment) mortgage you are using your capital to actively reduce your debt at whatever the prevailing mortgage interest rate is. With a interest only mortgage you hope that your invested capital will achieve a better rate of return than the mortgage interest rate.

For an interest only mortgage to be a better option, you need to know that your chosen investment vehicle, be it ISA or pension or investment property will acheive a net return that is higher than your mortgage interest rate.

For example, say you have a 100k mortgage, your mortgage interest rate is 5%. If your mortgage is capital and interest, then at the end of the first year you might have paid off 3,000 (say).  At the end of the first year you are no longer being charged interest on the 3,000 you have repaid.

An interest only mortgage holder with the same mortgage balance and interest rate will, at the end of the first year still owe 100k. For this to be a financially better option your savings will need to achieve an investment return of at least 5% after tax to equal the benefit that the repayment mortgage holder has achieved

Acheiving a net investment return of at least 5% every year is not easy

For most people a capital and interest mortgage will be the best choice to make


Mortgage Term

A mortgage will have a maximum term as permitted by the mortgage lender, this is usually up to normal retirement age. For example if the elder applicant is 30 years old then a term of 34 years is potentially available.

Some lenders will allow a retirement age up to 75. In these circumstances, lenders look for evidence that it is reasonable to work to this age. If the applicant is employed is it acceptable by the employer for an employee to work beyond 65.

For a self employed person, is it reasonable for the applicant to continue self employment beyond age 65. Lenders will sometimes look at whether the occupation is manual or desk based.

Mortgage lenders are likely to specify a maximum term

If you extend the term you will reduce the repayments on a capital and interest mortgage.

For example, the monthly repayments on a capital and interest mortgage of 100,000 over 25 years with a mortgage interest rate of 5% might be 591 pcm. If we extend the term to 35 years, the monthly payment reduces to 509 pcm

Bear in mind that the longer the term, the more interest you will be paying back to the mortgage lender. For this reason it is a good idea to choose a minimum term that is consistent with being affordable and also maintaining your quality of life

With an interest only mortgage altering the term makes no difference to the monthly mortgage payments

Investments

Mortgage lenders will take an interest in how the mortgage will be repaid. Many lenders require that you have an investment in place prior to taking out the mortgage. Please contact us to discuss further.

The following investments have been popular choices for people with interest only mortgages.

Endowment policies : These policies are run mainly by insurance companies and friendly societies. They are regarded as low to medium risk investments. The fund managers invest on the stock market, in property and in fixed interest investments. Policies can be unit linked or with profits. Unit linked means that a value is calculated, usually daily which directly relates to the value of the underlying fund. Unit prices can be followed in the broadsheet newspapers.
A 'with profits' policy entitles you to a share in the profits of the insurance company. Issuing companies vary their annual bonus according to investment performance and anticipated future investment conditions. The variance in annual bonus has historically been small which provides a degree of security to the policyholder. A terminal bonus is also normally declared at the end of the term. Life assurance is included in the contract which will pay off the mortgage in the event of death.

Unit trusts : Predominantly stock market investments where your money is 'pooled' together with other investors in a fund which may be managed or unmanaged (tracker). There is a risk element to your capital as unit prices can fall as well as rise, and a periodic review would be recommended to ensure that the fund performance is adequate. This type of fund is quite flexible and tax free benefits are available if taken out within an ISA.

ISA : ISA's are tax free investments which can be used with an interest only mortgage.

Pensions : If you are eligible for a personal pension, you can opt to use part of your pension fund to clear your mortgage. This will obviously reduce the amount that you will have available to go towards your pension, however you will receive full income tax relief on your contributions. This means that a higher rate taxpayer paying 100 per month into a pension fund will in fact only contribute 60 per month, the balance being paid by the inland revenue. There are many different types of pension fund available and we would be happy to advise on this subject.