Mortgage Repayment Types - The Basics

A mortgage is a loan secured against a property. Because the lender has the building as security, interest rates will be lower than for unsecured loans or credit card debts, however failure to keep up monthly payments could result in repossession of your home. When you take out a mortgage, you must specify how you are going to pay it back, the most common method being to gradually repay it over the term, which is known as Capital and Repayment. The alternative is an interest only loan. Under a capital and repayment arrangement monthly payments first cover the interest due and the excess then reduces the balance of the loan. As the outstanding balance declines, monthly interest reduces and more of your payments go to repaying the loan. The alternative to capital and repayment is interest only. Under an interest only contract, you only pay the monthly interest and the balance of the loan remains unchanged. Although criteria was far more relaxed in the past, nowadays you must be able to show that you have a repayment vehicle in place which is likely to repay the loan on maturity. The most common repayment vehicle is still the endowment, however bad press means that they are now far less popular, with more borrowers opting for ISAs and Pensions. As well selecting either interest only or capital and repayment in isolation, it is also possible to have a mixture of the two to suit your circumstances. For example, if a particular borrower has an endowment policy with a forecast maturity value of half of the outstanding balance, then half of the loan could be interest only, with the remainder as capital and interest. More recently, offset mortgages have become more common and provide borrowers with an high level of flexibility, but also the potential to overspend. An offset mortgage links the balance in a current account to the outstanding mortgage balance for the purpose of the interest calculation. On the calculation date (whether daily or monthly), any positive balance in the current account will reduce the mortgage balance, resulting in a lower interest charge. The Interest rate for a mortgage is usually far higher than the interest which can be received by capital deposited in a current account, resulting in better overall value. Offset mortgages usually also provide secured overdraft facilities, but because the loan is secured, it is essential to maintain a degree of financial restraint as building up a substantial overdraft can result in the eventual repossession of your home.