Repayment methods

There are two ways to structure your ‘main’ or ‘principle’ mortgage repayment:

Capital and interest repayment

This is where you make one monthly payment to your lender which consists of the interest cost and an amount to reduce the capital balance. During the early years of a repayment mortgage most of your monthly payment is used to pay the interest and a small amount reduces the mortgage size. During the later years this relation switches round so that during the last few years most of your monthly payment is used to reduce the capital balance until you have finally repaid the entire mortgage.

As long as you maintain the monthly payment using this structure you are guaranteed to repay the mortgage by the end of the agreed term.

This is the safest and lowest risk repayment structure.

Interest only

A number of major lenders currently do not offer this option at all. Of those that do, their rules can be quite complex and strict.

This is where you only make interest payments each month and so at the end of the agreed term you will still owe exactly the same amount of money you borrowed, assuming that you have not increased the mortgage amount or made any lump sum payments to reduce balance.

Because you are not reducing the capital balance you will pay considerably more interest over the agreed term compared to the capital and interest repayment method.

The key advantage of this structure is that the monthly commitment will be lower than with the capital and interest structure.

However you will be left with a problem – you still owe the lender the full amount of the mortgage.

For this reason you need to consider carefully how you intend to repay the mortgage.

You could save money elsewhere and repay the mortgage in one lump sum at the end of the term. Typical savings for doing this include endowments, pensions and ISAs. These savings vehicles tend to be investment-based and so will involve degrees of risk that do not apply to the straightforward capital and interest structure.

If you intend using an investment vehicle to repay your mortgage then we would strongly advise you to take advice from a suitably qualified individual. Mortgages for Professionals advisers are not authorised to give this kind of advice but we may be able to refer you to independent specialists who are.

If you make no provision to repay the mortgage then you may have to sell the property. This is not necessarily a good position to be in if the property is your main home. However it may be considered a perfectly acceptable approach for buy-to-let properties. Indeed there may be some tax advantages to not reducing the mortgage. These need to be discussed with your accountant or tax advisor.

Where you decide when and how much you repay, you have to be very disciplined with your finances to make sure that you actually do repay the mortgage by the end of its term. This contrasts with the relative certainty offered by the repayment (capital and interest) method.

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