What is a repayment mortgage
A mortgage is simply a loan that is secured on a property. All loans are intended to be repaid at some point and the standard arrangement for a home loan is for the outstanding capital to be repaid over a period of years. Typically in the UK we arrange mortgages over twenty-five years but if you wish to pay your mortgage off quicker you can arrange a shorter term or if you wish to reduce your monthly payment you can arrange a longer term. You should bear in mind that the longer your payment term the more interest you will pay overall.
Repayment Mortgage – history
For many years all mortgages on homes in the UK were set up on a repayment basis. This meant that, in addition to paying the interest on the mortgage each month, the householder paid a little bit off of the outstanding capital.
In the early years of a capital repayment mortgage the amount paid off the capital is minimal and the bulk of the monthly payment is consists of interest. In later years, as the outstanding mortgage reduced, so does the element of the interest in the payment and therefore the capital is paid off more rapidly.
During the nineteen eighties a new kind of arrangement became popular – the endowment mortgage. Under the endowment mortgage arrangement your mortgage was paid on an interest only basis, in other words you were paying no capital back on your mortgage, simply servicing the interest each month.
Instead, the householder took an endowment policy which was an investment with a life insurance element that was designed to build up a sum of money over the long term and repay the mortgage capital at the end of the mortgage term.
This arrangement was quite attractive when inflation and interest rates were high as projected returns on endowments would normally outstrip what was required to repay your mortgage. This gave you the promise of some extra cash in your pocket plus the benefit of life insurance from the endowment along the way. As interest rates and market returns dropped during the nineties the endowment became less and less attractive as a proposition and concerns sprang up that many of them would not reach their intended payout level.
This, together with concerns from the regulator about the way the products had been, and were being sold, saw endowments become a thing of the past.
Whilst endowments were no longer being sold, interest only mortgages remained within the market and during the price booms many borrowers saw the ultimate sale of the property as a practical way to repay the capital, whilst enjoying the lower payments of an interest only mortgage along the way.
Repayment mortgage – todays position
Reduced growth in property prices now makes the interest only mortgage an extremely risky type of arrangement. If you set your mortgage up with no practical means of repaying the capital you could be facing an extremely large interest bill by the time that mortgage is paid and even the loss of your home if you find yourself unable to pay the interest or the capital at a later date.
This, plus pressure from the regulator, has led lenders to be far more cautious in offering interest only mortgages.
Lenders will insist on mortgages being on a capital repayment basis when deposits are less than twenty-five per cent.
If you have a particular reason to use an interest only mortgage, such as in a buy to let arrangement they are still a valuable option to you as a borrower.
Whatever you do, always the get advice of an independent mortgage broker.
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