When people purchase property, they usually don’t have all the cash upfront. The answer is to take out a mortgage.
A mortgage is a large loan secured against the value of the property. Over time you’ll repay your loan, though this takes an average of 25 years for buying houses in the UK. Some mortgage terms are shorter, and some are longer, though you can expect to be dealing with your mortgage for a significant chunk of adult life.
There are three types of mortgage to be aware of. Each type of mortgage has drawbacks and benefits, so you’ll want to look into your options carefully before you decide which to choose:
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Your mortgage options will depend on your financial situation. You can seek advice, but make sure that you’re getting help from a reputable advisor.
When choosing a mortgage, consider how much you can afford to borrow and payback. Don’t stretch the household budget too far. If you find that you can’t keep up with repayments, then your house might be repossessed. It’s better to settle for a slightly cheaper house than to lose your home because you can’t afford it.
Once you’ve worked out what you can afford, you’ll need to choose the type of mortgage you want. The lender or broker might offer several options before you choose which to apply for.
With all mortgages, you borrow capital, and you’re charged interest on your debt. This increases the amount you pay back overall.
Repayment mortgages have higher monthly payments than other types of mortgage you can choose. This is because you’re paying off your monthly interest whilst also reducing your capital. As your debt slowly decreases, the interest you’re charged will go down.
You’ll pay the same every month for your mortgage, but as your debt decreases and your interest charges reduce, more of your money will be used to reduce your loan capital. The rate you’re paying off your mortgage will increase over time.
With a repayment mortgage, you’re reducing your capital, so you’ll automatically become debt-free by the end of your agreed mortgage term.
Repayment mortgages usually have relatively high monthly payments. That’s because you’re clearing your debt at the same time as paying your interest.
If you choose to apply for an interest-only mortgage, you won’t be clearing your capital with your monthly payments. Instead, you only pay back the loan interest you’re charged, so your capital doesn’t decrease. Each month you’ll be charged the same amount of interest on your debt.
Treat interest-only mortgages as mortgages with minimum payments. Though you’re covering your interest, you’re not reducing the amount of debt you’re in overall. You’ll need to have a plan for repaying your mortgage by the end of your loan term.
If you choose an interest-only mortgage, you need to be sure that you can repay the capital – the money you borrowed. There are several popular methods for repaying the mortgage, but all that matters is that you choose an option that you can be confident will work. Your lender needs to agree that your chosen option has a high chance of success, so you will need to show that you’ve considered a worst-case scenario clearly.
You can build up savings in any account of your choice. Then, you can use your savings to repay your mortgage debt.
With a Stocks and Shares ISA, you’re investing your money and hoping for a good return. You can use the ISA and its tax-free wrapper to repay the money you’re borrowing.
You might decide to repay your mortgage using a pension lump sum. If you’re going down this route, you’ll need to get your timing just right.
Other assets can be a great way to pay back an interest-only mortgage. If you already have property, your lender can trust that the money you need will be available.
As you’re only covering your interest each month, your monthly charges will be lower. This makes your mortgage more affordable.
Remember that you’re only covering your interest charges with your monthly payments. Your debt isn’t decreasing, so you’ll need to find a way to pay back what you owe. One option is to make overpayments when you can, but you’d need to be sure that you’ll have enough money to do this by the end of your loan term. Another option is to hope that your property value increases so you can sell the house to pay back your mortgage and use the profit on another property.
A form of an interest-only mortgage, an endowment mortgage is connected to investment. The investment acts as a savings product, complete with life insurance, so your mortgage is paid off if you don’t survive the full mortgage term. It’s not possible to take out a new endowment mortgage, as these types of products have been stopped, but you might have an existing mortgage that still needs to be repaid.
With an endowment mortgage, you’ll pay every month to cover your loan’s interest charges. Your payment will also include some money that’s invested into your endowment product. The money that’s invested will hopefully grow throughout the duration of your mortgage term, providing you with money to pay the capital back at the end.
With an interest-only mortgage, you’ll still need a way to clear your debt. This is because your monthly payments only cover added interest. Hopefully, an endowment mortgage will resolve this by providing an investment that should mature with the money to repay your capital.
This type of mortgage is risky because it relies on successful investments to repay the money you borrowed. There’s no guarantee that your investments will do well. Just like with other interest-only mortgages, you’ll need a plan for repaying your capital if your investments don’t work out.
Lenders will decide what mortgages they’ll offer to each customer. It’s great to have a choice, but the lender is responsible for making sure your debt can be repaid. You’ll need to show the lender how you’ll pay back the capital, not just the interest you’re charging.
Seek advice to find the best mortgage. What works for one person might not be best for another.
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