Interest Only Mortgages
When you receive a home loan the mortgage lender will charge you an interest rate. Low interest rates and a booming housing market laid the path for the interest-only mortgage in the 1990's.
With an Interest only mortgage, initial repayments for the interest on the loan. When the mortgage term is complete, the original capital borrowed is still owed. To prevent loss of equity, borrowers are advised to make regular payments into an some kind of investment policy as well as their mortgage repayments.
What is an interest-only mortgage?
Repayments are made up of the interest on the loan and not the capital borrowed. When the mortgage term is finished, the capital borrowed is still owed, the outstanding balance is made up of payments that would have been made into an investment policy alongside the mortgage repayments.
Usually in the form of:-
The three main Investment policies are :-
- An ISA (individual savings plan)
- A pension
- An endowment
With an Interest only Mortgage the monthly payments are lower than a repayment mortgage as they are made up of interest, also your investment could become larger than your mortgage .
When the loan term ends, you still owe the lender the capital you borrowed at the start of the mortgage.
If your savings or investments do not cover this debt, you could face the having your home repossessed.
Interest-only mortgage | Advantages
- You will pay less each month than you would with a repayment mortgage because you are only paying back the interest on the loan.
- If the investment growth rate exceeds those estimated at outset you may be able to pay off your mortgage early or enjoy a lump sum at the end of the repayment period, in addition to paying off your mortgage.
- With Interest only payments life insurance cover is less expensive if bought separately
- Providing all repayments have been made your mortgage can be transferred to another property.
Interest-only mortgage | Disadvantages
- Interest only mortgage charges are higher
- There is no guarantee that you will have sufficient funds to pay off the mortgage at the end of the repayment period, You still owe the lender the capital you borrowed at the start of the mortgage When the loan term ends. If your savings and/or investments do not cover this debt, you face the possibility of having your home repossessed.
- Interest only mortgage are less flexible than other types of mortgages, you ability to stop and start premiums are not available. Some schemes charge penalties if you stop paying your premiums.
Endowment Mortgages
An interest-only mortgage supported by a combined investment and life assurance policy called an endowment policy. This is normally taken out with an interest only mortgage and used as a means of repaying the debt at the end of the mortgage term.
Selling your Endowment Policy
There are a number of reasons why you would want to sell your endowment policy. The main reason is that the projection when the policy matures is less than the original loan amount. Other reasons include: changes in your mortgage requirements, personal circumstances, employment situation or to raise capital.
More often than not if you return to the policy issuing office to surrender the policy the price they offer you could be considerably less than you would get by selling the policy to an investor. Once your policy has been sold it becomes known as a Traded Endowment Policy (TEP)
You must be aware though that once you sell your policy you will lose the life assurance cover that came with the policy and you should arrange replacement life assurance.
Endowment shortfalls
When an endowment policy matures if it is less than the original loan amount it is an endowment shortfall.
The last twelve months has seen increasing numbers of households receiving warnings to address their endowment shortfalls. People are being advised that action needs to be taken to ensure the repayment value of your property meets the value of your original loan.
- At the end of your loan term not only is there a risk of having to find the balance but also that you may loose your home.
- Many people do not seem to be responding to the advise in fact 70% of us have not addressed the issue.
There are a number of reasons why people has been slow to respond to warnings mainly:
- Many people think that the position will improve in the future and are waiting to take advantage of a market upturn.
- Customers believe that it is difficult to get additional loans or to move mortgages (a remortgage.)
For Endowment enquires on the subjects mentioned please visit the Endowment Mortgage Ombudsman at www.financial-ombudsman.org.uk/faq/mortgage.htm
- Endowment mortgage misselling
- Endowment mortgage problems
- Mortgage endowment complaints
Types of Interest Mortgages
Interest rates for a variable rate mortgage will tie in with the Bank of England's base rate,( set monthly ). Obviously If there is an increase in the rate, there will be an increase in your mortgage repayments, but if the interest rate falls you pay less.
With a fixed rate mortgage, you are charged the same rate for a set period of time, regardless of interest rates. fixed rates for between two and five years are most common, after which time the mortgage reverts back to either the standard variable rate or a base rate tracker.
This is helpful if you are on a tight budget and need to know your monthly outgoings exactly.
A capped rate is a mix of the "variable rate" and the "fixed rate". Borrowers are keen on this type because they know that the rates they pay will never go above a predetermined level (hence "capped rate"), borrowers will however profit from lower rates when the lender's standard rate drops.