How you repay your mortgage can be as important as the interest rate you borrow at. But do you go for the security of a repayment mortgage or are you willing to accept the long-term risks of an interest-only mortgage? We weigh up both options for you.
When thinking about a mortgage, one of the things you first need to consider is how you are going to pay back the capital that you borrow.
The two main options currently available to you are: repayment mortgages or interest-only mortgages.
Repayment mortgages are many people’s preferred choice. They work by paying off an even portion of both the interest and the capital amount every month. The amount you pay off is calculated so that by the end of your mortgage’s term, say 25 years, the capital amount will be paid off in full and your house will belong to you.
As the name implies, taking out an interest-only mortgage means that you will only be paying off the interest on your mortgage each month - none of the capital. The idea is that you invest the money that you save by making lower monthly repayments in a ‘repayment vehicle’, such as ISAs, Investment Funds or Pensions Plans. You then use the funds from your repayment vehicle to pay off the entire mortgage balance at the end of its term.
Does the idea of low monthly payments sound appealing or is financial security more important for you? Before you rush to any decision, let’s first look at the advantages and disadvantage of both mortgage options.
Lower monthly payments could make this a cheaper/more affordable way to get on the property ladder.
Which type of mortgage is best for you boils down to a simple question: are you willing to accept the risk that comes with an interest-only mortgage in order to reap any possible benefits?
If you’re itching to get on the property ladder as cheaply as possible then an interest-only mortgage can look appealing to a first-time buyer. Likewise if you are confident in your ability to operate a profitable investment vehicle or you have the finances to cover any shortfalls if your investment vehicle doesn’t perform as expected - then an interest-only mortgage could be for you. They also appeal to buy-to-let investors who can claim back tax on mortgage interest and also use their spare cash to renovate their property.
If you do take out an interest-only mortgage, it does not mean that you are stuck with it for the full term. Although there will be a cost involved, it is possible switch to a repayment mortgage and vice-versa if you are struggling to meet your monthly payments. You can also try to reduce the risk by going for a part repayment, part interest-only mortgage.
Of course, many people are rightly wary of using a risk-based investment to secure their home – especially in the light of the recent worldwide financial turmoil. When you consider the consequences of failing to pay off the capital amount from your interest-only mortgage, it is a risk many of us wouldn’t be willing to take.
As in the tale of the Tortoise and the Hare: slow and steady may take you longer to get to your destination, but with a repayment mortgage you are at least guaranteed to get there!