Repayment Or Interest Only Mortgage. What Are The Differences?

Although we all know that there is no such thing as a free lunch, and borrowed money has to be repaid sometime, the interest only option is making the actual act of repaying seem more and more forgotten about. Therefore this article seeks to highlight the ways in which mortgages can be arranged so that eventual repayment is a priority.

Firstly, you need to understand how mortgages are set up. Regardless of the many types of interest deals around, mortgages come in two basic forms. Capital repayment and interest only.

No matter which one you choose there will be some form of interest to be paid. With a capital repayment mortgage you pay interest on the mortgage plus a small amount of the capital borrowed so that the loan is gradually reduced every month. If you choose this form of mortgage over, say, a 20 or 25 year period, at the end of the period the loan will be paid off.

Interest only is equally simple in so much as all you give the lender is interest. The capital stays outstanding in its entirety until it is repaid in some other way. You are probably thinking why on earth anyone would have a debt that does not get repaid. Well in answer to this there are quite a few ways that interest only mortgages can be repaid normally. One way is to arrange something called a repayment vehicle.

An endowment policy is one method which up until recently proved a very popular choice. Basically an endowment is a life insurance policy designed to run in conjunction with the timespan of the mortgage but which also generates cash through contributions and returns on investment. Think of it as a separate account that by the end of the mortgage term will have enough money in it to pay off the original debt.

However, with an interest only mortgage you really only need to gather enough money to pay off the initial loan so there are other ways to go than just endowment. A pension policy can also generate enough cash to give out a lump sum as well as a pension, and so could be employed as your repayment vehicle. All you need to assure is that the money you are paying into a pension policy is enough to guarantee that at the end of the term you have sufficient tax free money to pay off your debt on your home whilst also leaving enough extra to give a pension. Pension link mortgages can be a very attractive option, in particular when you consider the tax benefits attached to them.

Savings plans, personal equity plans and even personal savings accounts can all be used as repayment vehicles now. But in honesty any type of savings plan, including unit trusts and bonds, can be used as long as they create a sufficient lump sum. However, with that, it must be remembered that with any sort of investment plan you are always at risk if it doesn't produce the returns you were hoping for.

So in conclusion there are repayment mortgages and there are interest only mortgages but with interest only you have the added responsibility of ensuring you have a suitable repayment vehicle. It is always recommended that anyone getting a mortgage should seek professional mortgage advice whether it is for repayment or interest only mortgages but that advice is far more necessary if you are considering interest only with a repayment vehicle because the risks associated with getting this choice wrong can cost many thousands of pounds.