Interest Only Mortgages UK.

To some people, an interest only mortgage means that their monthly mortgage payments will be a good deal lower than it would be with a repayment mortgage. Sure enough, if you look at the results of most mortgage calculators, it should show you the monthly payments for both types of mortgage, and the interest only payment will be about two thirds of repayment payments. What people need to realise is that you really are paying off only the interest on the mortgage, and you will still be liable for the capital repayments at the end of your mortgages term.

Because of this, an interest only mortgage will contain three components. The first component is the interest you owe on your mortgage to your lender. The second component will be a payment into an investment vehicle that will be used to build up the funds in order to pay off your remaining capital at the end of the mortgage term. The third component is some sort of life insurance premium in order to enable your dependants to pay off your mortgage should you die.

Whilst the insurance covers you for some risks, the investment vehicle will cause some risks, as you cannot be guaranteed that your investment vehicle will result in sufficient capital in order to repay the entire mortgage debt when the mortgage term is ended. You should keep a careful eye on how your investment is performing and maybe bump up the payments in to ensure it will repay the capital. Should your investment vehicle overperform, you could end up with a healthy lump sum at the end of the term or you can repay the capital early.

The choice of investment vehicle is vital, and there are three options that are most widely considered. The ISA, the endowment or the pension mortgage.

The Individual Savings Account (ISA) mortgage is a tax-free investment. Should the money you pay in perform well, you can get a surplus after the mortgage is repaid, which will be tax-free. There is no guarantee that the loan will be repaid with this money, so do not count on it.

The endowment mortgage is where you invest money with an insurance company in certain funds that will accumulate, again with the aim of having surplus with which to pay off the mortgage and give you a lump sum. This is not guaranteed either.

The pension mortgage uses the 25% of your pension that you receive as a tax-free lump sum to pay off the mortgage at the end of the term. This includes a built in life cover component as well. You would need to be comfortable using retirement funds and realise you can't access the fund until you are 50.

 

 

© AskFinancially.com 2008

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