Repayment options
This content applies to England only.
Housing laws vary between England and Scotland. Get advice relating to Scotland
There are two basic options for home loans; repayment mortgages and interest-only mortgages. It’s important to remember that costs, risks and flexibility will be different depending on the mortgage provider.
Repayment mortgages
With a repayment mortgage, each month you repay some of the capital as well as interest on the sum still outstanding. In the early years you pay more interest than capital, but provided you keep up your payments, your mortgage is guaranteed to be paid off at the end of the loan term. This means that the repayment type of mortgage generally carries the least risk.
Interest-only mortgages
With an interest-only mortgage, you pay interest to the lender but you don't repay any of the capital until the end of the mortgage term. Instead, you can pay into a long-term savings plan, which will hopefully clear your mortgage debt when it matures, although there is no guarantee that it will do so.
There are three main types of interest-only mortgage where you pay into a long-term savings plan:
ISA mortgages
The most common type of interest-only mortgage plan is an ISA mortgage is where the savings plan is through an Individual Savings Account (ISA), a tax-free bank account.
The main disadvantage of an ISA mortgage is if interest rates are very low, these policies will be unlikely to repay your mortgage at the end of the term.
Endowment mortgages
An endowment mortgage is basically a combination of life insurance and a savings policy. These used to be popular but they have higher setting-up charges and less flexibility than ISA mortgages and now have little to recommend them.
Pension-scheme mortgages
A pension-scheme mortgage – is where you use part of your pension fund to pay off the loan. This is mainly suited to self-employed people and higher rate taxpayers.
Costs and risks
A repayment mortgage guarantees that your monthly payments will cover your loan. However, monthly payments may be a bit higher than for an interest-only mortgage.
Interest-only mortgages are more risky than repayment mortgages. If you have an investment, there’s no guarantee that the proceeds from the endowment, ISA or other policy will cover the whole sum you originally borrowed. You may be left with a shortfall that you will have to pay off from your other savings or income at the end of your mortgage term.
Many borrowers are now finding that their endowment policies will not cover their loans and are being advised to top-up their cover by increasing their monthly payments or taking out an additional plan to cover the shortfall, for example. If you are in this situation you should get expert advice, as you may be entitled to compensation.
If you don’t have an investment linked to your mortgage and house prices go down, you will lose money.
Cashback mortgages
Some lenders offer cashback deals where you get a percentage of the loan - for example five per cent – to spend on your move or whatever you choose. You may prefer not to go for this unless you really need the money, as the deal may tie you to a higher standard rate of interest for a number of years.
Flexible mortgages
A 'flexible' mortgage gives you more freedom to repay at the speed you choose. You may be able to increase or decrease your monthly payments, building up credit you can draw on, or taking a payment holiday where you pay nothing for a few months – but you're unlikely to get this flexibility and a very cheap interest rate.
Current account mortgages
A current account or all-in-one mortgage combines a flexible mortgage with a current account in one package. Money in your current (or savings) account can be set against the amount you owe on your mortgage or other borrowing, so that your interest payments are reduced.
