Advice on Mortgage Types
Most people who buy a house or flat borrow at least part of the money to do so from a high street bank or building society in the form of a mortgage. This loan is secured on the property, which means that the house can be repossessed if you don’t keep up your repayments. Mortgages comes in several different forms, and you will need to decide which method of paying back the loan is best for you.
Repayment mortgages, the simplest form of mortgage, are normally repaid gradually over 25 years. In the early years your repayments are made up of mainly interest and just a small amount of capital, whereas in the last years you pay mainly capital and very little interest.
If you have a family who depend on your income, you will need to take out life insurance. This will pay off the outstanding loan if you die early. Or there are special mortgage protection policies available where the sum insured reduces along with the loan.
With an endowment mortgage, you repay your mortgage out of the proceeds of an endowment insurance policy. This is a life insurance savings plan which gives a small amount of life insurance, the rest going towards a savings plan calculated to give at least the amount of money needed to repay the loan after 25 years.
If you die before the 25 years is up, the life insurance repays the loan. The final sum paid out is not guaranteed, but most policies pay more than the amount needed for the loan.
Don’t let your mortgage lender pressure you into an endowment mortgage. Remember, they earn commission from the insurance company on each endowment mortgage they sell.
Pension mortgages are particularly suited to self-employed people and those with personal pension plans. You repay the mortgage out of a tax-free lump sum which you can take at retirement instead of part of the pension. If you have dependants, you will need life insurance.
• The monthly payments on pension mortgages are expensive, but if you already have, or need, a personal pension, this is an option worth considering.
The proceeds of a Personal Equity Plan (PEP) are used to repay the mortgage. PEPs are stock market investment schemes on which you pay neither income tax nor capital gains tax.
PEP mortgages are flexible. If the stock market does well you can cash in your plan when you like and repay some of the loan early. But there is a risk that the stock market may be in the doldrums when you are due to pay off the mortgage. If you have dependants, you will need life insurance.
Some mortgage lenders only ask you to pay the interest during the period of the mortgage: it is up to you how to repay the loan. Others may not require you to repay the loan at all; it is repaid from the proceeds of your estate when you die. If you have dependants, you will need life insurance.
• These mortgages have the cheapest monthly repayments, but if you never repay the loan, you will ultimately pay a great deal of interest. They may be a good idea if you don’t earn much now but you expect to later in life, or if you know you will come into a large sum of money.
You repay the loan with a unit-linked life insurance plan. It is similar to an endowment policy except the savings are linked to a unit trust.
• Unit-linked funds often do better than endowment policies, but there is a risk of having to repay your loan when the stock market is in decline.
• The monthly payments are similar to an endowment policy.
Some low-start mortgages extend the mortgage period by a couple of years to 27 years on the understanding that you take out an endowment policy after two years. You save by having no endowment payments for the first two years. Others offer deferred interest, which add some of the interest due in the first few years to the outstanding loan. This keeps the monthly payments low but the size of the outstanding loan gets bigger, so you’ll pay more in the long run.