Buying a house is one of the most important things you'll ever do. So, you do need to think about your mortgage. Take some time to think about what kind of mortgage you should get. Since you will be spending your own money, I would suggest using it in the best way possible.
What kinds of mortgages you can get
There are thousands of different mortgages on the market right now. Each one offers something different or similar, but they all fall into one of two main categories:
- Repayment and Interest: With a repayment and interest mortgage, you (the lender) will have to pay back the loan amount plus interest by a certain date. For example, if you borrow GBP100,000 over 25 years, you will pay back GBP190,000, which is the total amount plus interest. Over the course of the loan, the balance will get smaller and smaller.
- Interest only. With an interest-only mortgage, you only pay the interest on your loan. However, when the term of your loan is up, you are still responsible for the amount you paid to buy the house in the first place. Using the previous example, this means that there is still GBP100,000 to pay. When you get an interest-only mortgage, you'll need a different way to save money, like a pension, an I.S.A., or an endowment. These other plans work with your mortgage to save up the last bit of money to pay off your balance when the term is over.
Pros of a mortgage with payments and interest
- If you have a mortgage that you have to pay back, you do not always have to get life insurance. Some pension plans do pay out if something bad happens, like death.
- You can pay off chunks of your mortgage at once to reduce the balance and shorten the term. But be careful, because some lenders will charge you if you pay off your loan early. If you decide to pay off your mortgage early, it's best to do so when your mortgage term is up and you can start a new discounted term with another lender.
- You know how much your mortgage is worth and how long it will take to pay off, so you always know when it will be paid off in full.
Problems with a mortgage that you pay back with interest
- In the first few years of paying off a mortgage, most of the money you pay each month goes toward interest instead of paying off the principal. For lenders who move often, this can mean that they don't get much of their capital back.
- If there is no life insurance, pension, or other money to pay off the house. Even if someone dies, the house will still have to be paid back. If payments aren't made on time, the house will have to be sold.
If you put extra money into your mortgage account, you might have to pay a fine.
Mortgages with only interest
With this type of mortgage, each payment goes only toward paying off the interest. After the mortgage term is over, say 25 years, the lender is left with the full amount needed to buy the house in the first place. If you don't have enough money to pay back the loan when the term is up, the lender can get another policy to go along with the mortgage payment. These are ISAs, pension plans, and endowment policies. When you find the right policy? The policy will grow at the same rate as your mortgage, so that the rest of your initial payment will be paid off by the time your mortgage is paid off. So at the end of the loan term, you'll have enough money to pay off your balance.
Plan for pension
Putting money toward your mortgage balance in a pension plan is a tax-free way to save. The rest of the money for your house will be saved up over time until you can pay it off. If you do plan to use a pension fund to save for the rest of your house, you might want to think about opening another pension fund for your retirement.
ISA Plan
With an ISA plan, you use an Individual Savings Account (ISA), which is a tax-free way to save, to buy stocks and shares. This way of saving money might not work for most people. Before you decide to go with this option, you should talk to a free financial adviser.
Endowment
The most common type of interest-only mortgage is still an endowment, which also offers life insurance and a fixed payment for investing. Both the endowment policy and the interest-only mortgage should end at the same time. At that point, you should own your home outright and have nothing left to pay. Endowments have gotten a lot of bad press because investors were told they would get a high return on their investments. But lately, this hasn't been the case. Borrowers have found that their investments haven't done as well as they thought they would, and the amount of money invested won't be enough to cover the amount owed on the property.
Even though there have been problems with endowment policies recently, it is important to remember that the returns on endowment policies have been pretty good, but you do need to see the term through to the end. Also, life insurance is part of an endowment policy, so if the worst happens and the person dies, the mortgage is paid off in full.
Pros of a mortgage that only pays the interest
- Your investments and savings could add up to more than the amount needed for the last payment. This could give you more money for your own needs.
Some plans offer good tax breaks and help you reach the goal amount faster and for less money.
What are the bad things about an interest-only mortgage?
- If your investments don't bring in the money you need to pay back your loan, you may have to make up the difference. If you're worried that your investment won't be enough, you should stay in touch with your investor and ask for regular updates on how your endowment is doing. If the worst happens, you can increase payments to make up for the investment you lost.
- When you cash in your endowment, ISA, or pension, it could hurt the amount of money you've saved over the years. If you decide to cash in any policies you already have, you may have to pay a penalty. This could be a cash amount set by the investment company or lender. If you are worried about how your finances will turn out in the end, please talk to a professional. Don't be too quick to make a decision, as most policies build up more cash in the last year.
