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Interest Only Mortgages

Money is lent on the basis of payback to the lender with interest. However the capital lent sum, without further provision, does not reduce. An interest only mortgage requires you to make monthly payments to the mortgage lender to cover the interest on the amount borrowed. It is neccesary to establish a separate long term investment plan that will accumulate enough funds to pay off the full loan amount in your planned period of time.

With an interest only mortgage there is no repayment term since the mortgage is only payed off on adequate maturity of investment plan provisions. As such the interest-only mortgage continues at whatever rate agreement has been chosen until other funds are available to pay back the borrowed capital sum.

The investment plan required to pay off the mortgage usually comes in one of three forms; an ISA (individual savings plan), a pension or an endowment. This investment does not have to be provided by the mortgage lender.

Advantages


  • You can choose an 'investment vehicle' that is tax efficient.

  • 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.
Disadvantages
  • You have no guarantee that you will have sufficient funds to pay off the mortgage at the end of the repayment period, as the investment could perform below that assumed at the start. (By monitoring your investment's performance you could make additional contributions during the repayment period if you felt the fund was under performing.)

  • Some forms of investment may incur a penalty fee if you stop paying premiums.

  • Your debt remains constant throughout the mortgage period.
Pension Mortgages A pension mortgage is an interest only mortgage with an additional investment plan in the form of a personal pension. A personal pension is a stockmarket based investment that benefits from tax relief and tax free growth.

A pension pays a tax free lump sum and a monthly taxed income on retirement. The lump sum is normally used to pay off the mortgage.

Advantages
  • Pension contributions benefit from up to 40% tax relief for higher rate tax payers.
Disadvantages

  • Your debt remains constant throughout the mortgage period.

  • You have no guarantee that you will have sufficient funds to pay off the mortgage at the end of the repayment period, as the pension fund could perform below expectations. (By monitoring your pension fund's performance, you could make additional contributions during the repayment period if you felt it was under performing.)

  • The lump sum cannot be used for other purposes. You therefore need to ensure that your level of pension contributions are sufficient enough to maintain your required standard of living during retirement.

  • The mortgage period may be longer than 25 years, depending on your age. You will still need to meet interest rate payments throughout this period.

  • The tax situation regarding pensions is open to unforseable changes.


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