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Mortgages are loans secured on your property. You are most likely going to be applying for a mortgage, if you are buying a house or a flat. Few of us are fortunate enough to buy a property outright in cash.

Banks and building societies are falling over themselves to lend money for mortgages. Historically, property prices have always risen steadily over the long term. For this reason, properties are considered a very safe investment. To mortgage lenders, they represent a very safe form of security for a loan. For property buyer, it is better to be paying off a mortgage than to pay rent, since rent represents money down the drain. Even though, interest on a mortgage may be costly and even painful at times, at least they will have property to call their own, once the mortgage is paid off.

Obtaining finance for property is not the only reason for a mortgage. Since mortgages are considered lower risk loans by lenders, interest rates are substantially lower than charged for unsecured loans. Hence, for the borrower, mortgages offer a very low cost borrowing option. You may have a mortgage-free property or have paid off a sizeable part of your mortgage, giving you the option to borrow more money secured on your property. Many people make use of this mortgage facility to finance things like a new car, improvements to their property or for starting a business. If you still have a mortgage and wish to increase the amount borrowed, this is termed re-mortgaging.

It must be stressed that you should never borrow more than you can afford. You need to be sure that you can afford to repay the mortgage or risk losing your home. Most reputable lenders insist on assessing your financial means.


Types of Mortgage

There are basically two types of mortgage available: repayment mortgages and interest only (endowment, pension, ISA etc.). Within these types there are numerous options to choose from, like flexible mortgage, discount variable interest rate, fixed rate etc.

Lets take a look at the most common types of mortgage and options:

Repayment Mortgage

With this type of mortgage, you pay off the borrowed capital in fixed monthly installments. Interest is also paid monthly calculated on the reducing balance.

If the capital is a fixed amount each month, then repayment along with interest will be very high initially, gradually tailing off to paying very little interest towards the end of the mortgage. Since this can make it difficult for borrowers to service the repayments initially, most mortgage lenders setup a repayment schedule to make the monthly payments fairly level. This means that less capital is paid off initially, then in increasing amounts each month. Towards the end of the loan, it will be mostly capital this is being paid off in each monthly payment. To illustrate this, we will take a theoretical example of a mortgage for £100,000 at a constant APR of 10% paid over 25 years.

The first years payments will be:


The final years payments will be:


Endowment Mortgage

An endowment is one of the interest only type mortgages. i.e. You only regularly pay interest on the outstanding balance of the mortgage on a monthly basis. Rather than repay the capital of the mortgage monthly, you make regular payments towards an endowment policy. At the end of the mortgage term, the endowment policy matures and is used to pay off the mortgage in a lump sum. Hopefully as well, there will be a surplus from the endowment policy, tax free, for you to enjoy. The lender will require a legal clause on the endowment policy to guarantee that the policy will be used to pay off the mortgage.

Endowment policies may be linked to investment funds such as unit trusts or may be invested with the insurance company's general funds. Endowment policies are life assurance policies, as such, the premiums and returns are affected your age and state of health. Premiums can vary between different life assurance companies as well as the performance of the policy itself.

If the endowment policy is linked to stock market investments (where the value of investments can go down as well as up), you may not receive sufficient funds at maturity to pay off your loan. You need to make your own judgment about future returns from the stock market - mortgage lenders and financial advisers may not give the best advice on this type of mortgage as they stand to earn commissions on selling you these types of mortgage.

Pension Mortgage

This type of mortgage may be very attractive to the self-employed or those who are able to arrange a personal pension plan. Pension mortgages are very similar to endowment mortgages. You are only paying the interest to the mortgage lender on a monthly basis. Rather than paying endowment policy premiums, you will be contributing to a private pension plan. The Inland Revenue permits a proportion of the pension fund to be taken out in cash on retirement, this can be used to repay the loan.

The attraction of a personal pension plan is that if the policy is written to the Inland Revenue rules, pension premiums can be offset against income tax, even at the highest tax rate. For example, if you were a higher rate tax payer and the higher rate is 40%, when you contribute £600 towards your pension plan, the Inland revenue will contribute £400 towards your plan. The Inland revenue contribution does however reduce according to the appropriate tax bands.

Unlike an endowment policy, the lender cannot take a legal charge on your pension plan, you will have to provide a sound undertaking to the lender for the lender to repay the loan from your pension fund for the lender to make you an offer.

Flexible Mortgage

As the name implies, a flexible mortgage offers you some degree of flexibility in repaying your loan. You are able to over-pay your monthly repayments, under pay your monthly repayments or even stop paying for a while.

When you over-pay, it is simply a matter of writing an additional cheque to the lender to pay off more of the loan capital. Under payment or stopping payment for a while involves making a prior agreement with the lender.

The attraction of flexible mortgages is that if you see your financial circumstances improving in the future, you can pay off your mortgage sooner. In some cases, mortgage lenders may charge you for paying off the mortgage too soon. You should check with your lender about their conditions of paying off the mortgage only.

The other attraction of flexible mortgages is that if you see you will occasionally have cash flow difficulties or need money for a really special occasion, stopping payment of the mortgage will allow you to have more cash to use for a while. Stopping payment will mean that you will have more interest to pay the lender in the longer term.


Further Information

Your Mortgage
Web site of your mortgage magazine, offers comprehensive and up to date information about mortgage options and lenders in the UK. Site shows comparison tables of mortgage offerings and has tools for calculating what you can borrow.

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