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Repayment Methods -
Anyone that has ever taken out a mortgage knows that there are two main repayment methods accepted by the UK’s lenders, Interest Only and Repayment.
The interest only method of repayment means that monthly payments only pay off the interest charged by the lender on the original loan taken out. It does NOT pay off any of the capital unless overpayments are made and providing all payments are made when due, will leave you with the same balance that you started with when your chosen mortgage term expires.
The longer the term the more interest you will pay and reducing the term will not result in a reduction of your monthly payments as you are only paying off the interest.
So why take out interest only if you are not actually repaying your mortgage?
Interest Only is meant to be used in conjunction with a repayment vehicle such as an endowment or ISA which at the end of the same term of the mortgage should give the client a lump sum to repay the mortgage plus (if you’re lucky) also give you a little extra to spend as you wish. Adding the cost of the mortgage repayments to the investment plan should, in theory, equate to a similar payment to a client choosing a repayment mortgage however with the added benefit of a possible lump sum at the end.
However in reality as these investment vehicles are generally affected by the stock market, the value of these plans has dropped considerably in recent years leaving some borrowers with an unexpected shortfall. The amount paid out has not reached expectations and some borrowers are being left with a debt instead of a surplus.
Investment companies are now reviewing these plans and contacting their clients if their plans are not on target to reach the required amount. Clients may be requested to increase the monthly amount contributed in some cases to improve the performance of their investment plans.
The reason why borrowers choose interest only is usually the cost as paying the interest is cheaper than paying the interest plus some of the debt every month. Over recent years some lenders have chosen to accept Interest Only as a method of repayment without a repayment vehicle attached and accept that the debt will be repaid when the property is sold. These lenders know that as house prices are rising, the mortgage will be repaid once the property is sold. Whilst this is fine for the lender, where does it leave the borrower? This is a question to consider for the future however for many new borrowers and those yet to enter the housing market, it may be the only way to get on the property ladder and be able to afford their monthly payments.
Repayment mortgages are where both the interest and capital are paid off simultaneously each month thereby reducing the amount of the debt throughout the term of the mortgage.
The amount of debt repaid per month changes throughout the term of the mortgage with mostly interest being paid in the first few years. It is NOT split 50/50 so clients redeeming their mortgages during the early years may not see the kind of reduction that they may expect.
The lender will calculate how much is required each month to repay the mortgage over the required term and therefore any reduction or increase in the original term will affect the monthly mortgage payment.
The net result of this, providing that all monthly payments are made when due, is that at the end of the mortgage the debt will be repaid in full.
As borrowers become more aware of the risks of investment plans, more and more people have been choosing repayment mortgages as it is guaranteed to repay your mortgage at the end of the term.
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