Which Home Mortgage Should I Choose?
When looking at mortgages there is a choice to be made between two fundamental types. These are repayment or interest-only mortgages, and each has their own benefits and drawbacks.Your eventual choice between these two types, and between any one of the numerous varieties of each type, will ultimately rest on your individual circumstances, but there are certain factors to be taken into consideration with both.
RepaymentThe most common type of mortgage is the repayment type. Under this arrangement, the creditor agrees to lend you a certain sum of money, which you will then repay in increments over a period of time. This period can be long, particularly as such large mortgages are now available; one high street bank is now offering a loan of five times your annual income. With a repayment mortgage, your monthly or quarterly payments to your creditor will also include interest on the loan.
Repayment mortgages are a very low-risk option as, if you keep up the repayments, you are guaranteed to have paid back the entire loan over the course of the mortgage (or the 'term'). However, these arrangements tend to be structured so that the repayments that are made in the early part of the term tend to be made up mainly of interest. As a result, if you move early on during your mortgage, you will find that you have paid back very little of your actual loan. However, for most people the fact that there is virtually no risk involved and no self-discipline required (short of actually making the payments) outweigh the potential negatives.
Interest-OnlyThe other major type of mortgage is the interest-only arrangement. With this type of mortgage, the debtor is required only to pay the interest on their loan in monthly installments. The actual loan is paid back as a lump sum at the end of the term. As a result, interest-only mortgages are always coupled with other arrangements for paying back the loan; depending on the arrangement you have with your creditor, these arrangements will either be made for you or you will be left to make your own.
Any type of investment can be used to amass the funds needed to pay back an interest-only mortgage, but there are three main types offered by lenders. These are called ISA, pension and endowment mortgages. Many people assume that ISA mortgages are the lowest-risk as they associate them with cash ISAs. However, in these cases the ISA in question involves investment in stocks and shares and, as such, they are high-risk; if the market falls, your ability to pay back your loan may suffer. On the other hand, ISA mortgages are flexible in that you can hold off on your investment if you run into financial troubles. Conversely, if your investment does well, you may be able to pay back your loan early.
Think About the FutureNeither pension nor endowment mortgages are particularly popular today, as they both have considerable downsides. A pension mortgage works on the basis that you will pay into a pension fund during the term of your loan. On retirement you can withdraw 25% of your pension as a lump-sum, and it is assumed that you will use this to repay your mortgage. While this is a tax-efficient way of borrowing, the implication is that you will need to build up a pension fund which is four times the size of your mortgage in order to be able to pay it off. This scares many people off, while younger borrowers tend to shy away from the prospect of paying interest for the rest of their working life.
Endowment mortgages are now virtually non-existent. They work on the basis that a fund would be set up for you that was used to invest in the stock market. However, the high risks and very high initial outlays associated with these ventures outweighed the positives brought by the fact that endowment mortgages came bundled with life insurance that paid back your loan were you to die during the term.
Unless you already have substantial investments or are confident that you would be able to keep up payments into, for example, an ISA, a repayment mortgage is probably the most sensible way of borrowing. However, you should always look at these options in the light of your own circumstances.