What are the mortgage basics - Stage 1 Selecting the ideal loan?

First, you need to know about the two methods of repaying a mortgage, which are the repayment method and the interest-only method. As a basic rule, the repayment method will guarantee that you will pay off the loan at the end of its term. The interest-only method means that you pay the lender interest during the term, then pay the outstanding capital back at the end of the term. To do this you use an investment vehicle, the proceeds of which should pay off the loan. You may end up with a surplus, or maybe a shortfall.

The repayment mortgage means that each month you make a payment to your lender consisting of both the interest on your loan and a repayment of part of the capital. Thus, your monthly repayments will be higher with an interest-only loan. You are reducing your debt every month, which should give you peace of mind. You will need to arrange life assurance, so that should you die before the end of the term your mortgage will be paid off.

An interest-only mortgage is more complicated. You need to make monthly payments of interest to your lender, on premiums for life insurance, and into an investment vehicle that should result in your outstanding capital being paid off at the end of the term. Now, when you add all these payments up, you will find that interest only payments are slightly cheaper than a repayment mortgage, but you get more risks for this. You get no guarantees that your investment plan will pay off your outstanding mortgage debt.

There are three main types of investment vehicles to be used to pay off the mortgage capital. The endowment mortgage is where you invest with an insurance company in an endowment policy. This could be a "with profits fund" or a "unit-linked" policy. These policies will grow, hopefully enough to pay off your mortgage leaving you with a lump sum. You could also be left with a shortfall though.

A pension mortgage is where you use the 25% lump sum from your pension fund to pay off the mortgage. You can't get hold of this money until you are 50, and you are not guaranteed that it will be enough, but it is very tax efficient, as you get your highest level of tax relief on your contributions.

Finally, an ISA mortgage is where you pay into an Individual Savings Account (ISA) and hope the fund grows enough to pay off the mortgage. Again, you could have a surplus, but again there are no guarantees. Also, the tax free nature of ISA's is not guaranteed and ISA's may not even exist in a few years time.

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© AskFinancially.com 2009

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