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Interest only Mortgages

A mortgage is effectively a personal loan that is obtained from a bank or building society used to pay for a property. The lender is then repaid in monthly instalments for a fixed period of time. As with personal loans, mortgages are subject to interest charges.

There are essentially two different classifications of mortgages: repayment only mortgages and interest only mortgages. Here we aim to identify the distinguishing characteristics of each type of mortgage, and the merits of each one.

A repayment only mortgage requires monthly repayments that consist of both interest charges and actual capital repayments; effectively the same as the repayment process for a typical personal loan. An advantage of this type of mortgage is that lump sum payments or overpayments can be made, which reduces the interest and capital amounts repayable. Also, at the end of the repayment term, the borrower is safe in the knowledge that the mortgage has been completely repaid. There is also a disadvantages in that the majority of repayments made early in the repayment term consist of interest payments. For a borrower who moves house frequently, this can be a hindrance as little of the actual mortgage gets repaid. Also, because it is not necessary to take out life assurance cover with this type of mortgage, the property will have to be sold to repay any debt that remains in the case of death of the borrower.

An interest only mortgage requires monthly payments that consist solely of interest payments. The capital repayments are paid into an alternative repayment vehicle such as a pension scheme, ISA or endowment policy; it is this repayment vehicle that provides the lender with the repaid capital at the end of the term.

Each type of repayment vehicle has its merits, but it is important to choose what is right for you. Buying a house is usually the biggest investment an individual will make in their lifetime, and mortgage repayments are normally required for anything up to 25 years after the mortgage has been issued. For this reason, one should seek professional financial advice if undecided about which mortgage plan is the one to go for.


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