Mortgage Repayment Methods

Repayment or interest only?
The key decision you have to make is between a repayment or interest only mortgage - you are either paying only the interest on the money you have borrowed, or both the interest and a portion of the capital. Which repayment method you choose will depend on your personal circumstances. The details given below are for guidance purposes only.

Repayment mortgages (Capital and Interest)
With a repayment mortgage your monthly repayments cover both capital and interest on the loan. If you keep up the repayments throughout the term, your entire loan will be repaid at the end of the mortgage term. No other repayment vehicle is needed, but your lender may insist on life insurance in case you die before the mortgage is cleared.

On the plus side, a repayment mortgage is simple, straightforward and easy to understand. It also avoids the risk of investing in the stock market for your repayment vehicle.

However, unlike a pension, ISA or endowment mortgage, repayment loans do not give you the opportunity to benefit from a rising stock market. Also, when remortgaging, people often choose another 25 year repayment mortgage, to keep the initial monthly costs down. This means that the overall total period of your mortgage debts combined increases over time.

Interest only mortgages
With an interest only mortgage, your monthly payments to the lender cover only the interest on the loan (i.e., they don't repay any of the capital). The full amount of the loan has to be repaid to the lender at the end of the term.

To ensure you can make this final payment, you invest additional funds in investments which are designed to generate enough (preferably more than enough) capital to repay the loan at the end of the term.

On the plus side, you can choose from a variety of investment vehicles, some of which can have tax advantages. And should you move or remortgage, your investment vehicle can usually be reallocated to the new mortgage.

However, unlike a repayment mortgage, the total amount of your debt does not reduce over time. And there is no guarantee that your chosen investment vehicle will grow sufficiently to repay your loan (although you can usually top up your contributions to investments as you go along if this looks likely to be the case).

This method will reduce your monthly repayments compared to a full Capital and Interest Mortgage, but as already stated will not ensure repayment at the end of the mortgage term unless you do something about it, or have other means to repay the mortgage loan at that time.

Split (Part Repayment and Part Interest Only)
If you prefer to accumulate savings to repay a certain amount of your mortgage loan, but would also like the certainty that a certain amount of your mortgage loan will definitely be repaid at the end of the term, this may be your choice.

The Repayment part of each monthly repayment will pay the interest due, as well as having the effect of reducing the capital outstanding on that part of the loan. If you keep up your repayments throughout the term the Repayment part of your loan will be repaid at the end of the mortgage term.

The Interest Only part of each monthly repayment will simply pay the interest due, and will not reduce the capital outstanding on that part of the loan. We recommend that a suitable repayment vehicle be put in place to ensure repayment of the Interest Only part of the mortgage loan at the end of the mortgage term.

This method will partially reduce your monthly repayments compared to a full Repayment Mortgage, but as already stated, will not ensure repayment of the Interest Only part of the loan at the end of your mortgage term unless you do something about it, or have other means to repay the mortgage loan at that time.

Tudorwood Mortgage is not authorised to offer investment advice. We strongly recommend you seek professional advice with regards to these topics if you believe they may affect you, prior to making a commitment.