There are many ways of repaying a mortgage, but which should you choose?
Repayment Mortgage (Capital & Interest)
Sometimes known as a 'Capital and Interest' mortgage. The original and traditional mortgage and regaining popularity due to recent concerns over the poor performance of some 'endowment' policies and allegations of miss-selling of these policies. The loan is repaid over an agreed period, typically 25 years. Your single monthly payment covers interest on the loan and part of the capital. During the early years, a large proportion of each monthly payment is interest, in later years more of the capital is paid off. This type of mortgage is simple, flexible and guaranteed to repay the loan at the end of the term providing all payments have been met. It is advisable to take out a life assurance policy.
For those seeking flexibility in their method of repayment. Each month you pay interest to the lender for the amount you borrowed and pay a separate premium into an investment plan. There are a number of investment vehicles that may be linked to this type of mortgage (see below). It is your responsibility to ensure that an adequate repayment method is in place and is maintained for the term of the mortgage. Level term assurance is usually required.
Your monthly premiums are pooled with other investors. At the end of the year a reversionary bonus is allocated to each investor and once awarded, these bonuses cannot be taken away. At the end of the term, the life company will pay a terminal bonus that may represent a large proportion of your final payout. This bonus could be as much as 50% or more, but it is not guaranteed. The policy aims to produce a cash surplus at the end of the term but is dependent on the investment performance of the life company. Endowment policies are easily transferred from one property to another and include full life cover
Endowment - unit linked
Your monthly premiums buy specific units in stock market linked investments and the value of these units can go up and down on a daily basis. Unit-linked funds have the potential for greater and faster growth that may enable you to repay your mortgage early or provide a surplus lump sum at the end of the term. However, there is also a greater risk than with a with-profits policy and again the returns are not guaranteed.
This is similar to an endowment mortgage but the loan is intended to be paid off from the proceeds of a pension plan. Personal pensions have built in tax benefits and the potential return is greater than from an endowment policy. As well as repaying the original loan, the plan provides a pension for when you retire. There are strict limits on the amount of money you can pay into a pension plan, the amount that can be taken as a tax-free lump sum and the age at which you can access the money. You may need to arrange separate life insurance if the plan does not provide sufficient cover.
Individual Savings Accounts were introduced to simplify and rationalise the range of tax-free savings vehicles available to the public. They work in a similar way to endowment policies where your monthly premiums are invested but the returns are tax-free. If the investment plan performs well you could be left with a considerable surplus after the mortgage has been repaid or you may be able to repay your mortgage early. Be aware that ISA's have maximum annual investment limits and for some mini ISA's this could be as low as £1000. This may not be sufficient to repay your mortgage at the end of the term. Again, an ISA is not guaranteed to repay your mortgage at the end of the term and you may have to arrange separate life cover.
