Mortgage Repayment Methods

Summary
Compare repayment and interest-only mortgages. Are you a risk-taker? You can use any investments to repay your loan.

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Every month your payment includes a proportion of the interest which your lender is charging on the loan, and part of the loan amount itself.

There are two main advantages of a repayment mortgage. Firstly, it is a low-risk option as by the end of the term it is guaranteed that the whole loan is repaid. And secondly, it is adaptable. For example, if you experience difficulties with repayments the term could be increased in order to reduce your monthly payments.

Interest-only schemes mean just that – you only pay interest on the loan for the length of the mortgage term and none of the amount you actually borrowed. You therefore need to have another arrangement running alongside to pay back the capital sum. This could be a stocks and shares ISA or another type of investment fund, but there's no guarantee you will accumulate enough to pay off the loan in the end so you need to be insured against that eventuality.

If you are lucky, at the end of the mortgage term you could end up with some extra cash, or you may have benefitted from making lower monthly payments than you would have done on a repayment mortgage.

However, at the end of the day you could face a shortfall and you might have paid more in the long run than if you had taken out a repayment mortgage.

There are some interest-only deals around where the lender does not dictate how you repay the capital sum at the end of the term. This is a high-risk option only suitable for those who have healthy investments in place which could be used to repay the loan eventually. We would advise you seek independent financial advice if considering this option.

Endowment policies used to be commonly linked with interest-only mortgages and many home owners still have a mortgage dependant on an endowment policy to some degree. In recent years many people have experienced shortfalls when their endowment did not provide as much as they expected at the end of their mortgage term.

Nowadays the market is wary of endowments and as a rule they are not recommended for interest-only mortgages.

You can use any investment to pay off your mortgage, for example an ISA mortgage or a pension mortgage, although the latter is not very common nowadays.