How does a repayment mortgage work?

Monthly payments are made up of interest charged on the amount borrowed and a portion of the capital to repay the mortgage. During the early years most of each month's payment are interest and it is only later on that you start to repay any significant element of capital.

Advantages

• The mortgage is guaranteed to be repaid at the end of the term providing that payments are maintained. You can see the mortgage reducing each year (albeit very slowly in the early yars).

Disadvantages

• It does not contain any form of savings, so there is no possibility of additional return or early repayment. However, the mortgage could be repaid early if payments are increased.
• You may need to take out seperate life cover to ensure the mortgage can be repaid if you die. You should consider the benefits of protecting your income, should you become ill and be unable to work.

How does an interest only mortgage work?

Monthly payments to the lender consist of interest only and the outstanding mortgage remains the same. You make payments to a separate investment with the aim of producing enough capital to repay the mortgage in full at the end of the term. There are a number of different investments that can be used. You can also use a combination of them.

Mortgage Investments

Monthly payments to the lender consist of interest only and the outstanding mortgage remains the same. You make payments to a separate investment with the aim of producing enough capital to repay the mortgage in full at the end of the term. There are a number of different investments that can be used. You can also use a combination of them.

Endowments

Advantages

• Regular reviews are carried out on many plans to ensure they will pay off the mortgage at the end of the term. If the underlying performance has been less than assumed, you may need to increase the contribution. However, if the growth on the fund is better than assumed you could receive a lump sum over and above the mortgage amount, or pay off the mortgage early.
• Life cover is automatically included in the plan. You may also be able to include critical illness protection and waiver of premium benefit.

Disadvantages

• If you stop the endowment early you may get back less than you invested.
• Endowments are only Suitable to repay long-term mortgages, e.g. at least 15 years.
• Endowments invest in the stock market and are not suitable for risk averse borrowers.

Pensions

Advantages

• Tax relief on payments.
• Part of the fund can be taken as tax-free cash, which is used to repay the mortgage.
• Favourable tax treatment of funds.
• A sum can be built up which can be used to provide an income in retirement.

Disadvantages

• Benefits can normally only be taken between ages 50 and 75 (age 55 from 2010).
• The amount of tax-free cash you can take is limited by legislation.
• Using the tax-free cash to repay your mortgage will reduce your pension benefits.
• As the pension is designed primarily to produce income in retirement you will need to actively monitor any targeted cash amount to repay your mortgage.
• There are limits on pension payments.

Individual Savings Account, ISA

Advantages

• All income and capital growth is free of personal UK income and capital gains taxes except the 10% tax credit payable on all UK Equity dividends.

Disadvantages

• A maximum of £ 7,000 can be invested in an ISA each tax year subject to annual review by the Government.
• The Government intends to review the terms and availability of ISAs in 2009.
• Some lenders may not accept ISAs.
• There is no monitoring of the fund to ensure it will repay the mortgage.
• There is a maximum of £3000 which can be invested in cash.

HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.

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