Repayment or interest only
Now you've found how much you can borrow, you'll need to decide how to repay your mortgage. You are going to have to repay your mortgage over quite a long time. There are two ways of doing this - repayment or interest-only.
Repayment
These are the most popular type of mortgage. With these mortgages, your monthly payments repay both the interest owed, plus a small amount of the capital (the amount you have borrowed) until the mortgage is paid off in full.
Key pros and cons of repayment
Pros
- Simple and easy to understand.
Cons
- At the end of the term your mortgage is repaid in full. With some repayment mortgages, the amount you owe (and so the amount on which you pay interest) is worked out just once a year, and how much you pay off each month over the year is not taken into account. So as a result, you're charged interest on money you've already paid off. This is less common now but it is worth checking to make sure.
How is the monthly interest worked out?
Each month you repay part of the debt and pay interest on the amount of the mortgage left. At the start, your mortgage debt never seems to change, as most of your monthly payment covers the interest building up on your mortgage. But towards the end of the term a bigger percentage of your payments go to repaying the capital, (the amount you originally borrowed) and you'll see the size of your loan shrink more quickly.
Interest-only
With an interest-only mortgage, your monthly payments cover the interest on the mortgage, but not the capital (the amount you originally borrowed). So at the end of the mortgage term, the amount of the original mortgage must be repaid. To make sure you can pay this off, you put extra funds in investments. The idea is that these investments make enough money to repay the mortgage at the end of the term. But because you are playing the stock market, which can go up or down, there are no guarantees you'll make enough.
There are a range of different ways you can invest your money to build up enough to make the final payment like endowment policies, tax-free Individual Savings Accounts (ISAs) and tax-efficient pension plans. You should speak to an Independent Financial Adviser (IFA) for help on what's right for you. These are independent experts who are authorised to sell or advise on the policies offered by insurance companies, as well as other financial service providers, such as banks and building societies.
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