There are two main ways to repay your mortgage, each has its pros and cons and you should understand your repayment options before rushing into setting up your home loan.
A mortgage is simply a loan secured on your property, which you pay back over an agreed period of time. ‘Secured’ means that if you don’t make payments as you agreed the mortgage lender has the right to sell your property to recover the money and including any accrued debts. In reality, events don’t often get this far, especially if you contact your mortgage lender as soon as you start having difficulties.
Mortgages are usually set up over 25 years, but it can be for longer or shorter periods, whichever you choose. The loan amount you initially borrow is called the capital, and needs to be paid back to the mortgage lender in the agreed timeframe plus any interest accrued. These are highlighted below:
Principal & Interest Mortgages
Principal & Interest mortgages are a box standard home loan secured on a property where you pay back some capital with your interest payments each month.
In the beginning you’ll be paying off mostly interest, so if you sell up in the early years you’ll find you’ve hardly paid anything off your mortgage. However, after a few years, you’ll be paying back larger chunks off your debt. Many mortgage lenders now offer ‘flexible’ principal & interest mortgages, so that you can make overpayments when you can afford to and take ‘payment holidays’ when you can’t.
A principal & interest mortgage is the surest and safest way to pay off a home loan and it’s the route you should be taking if you don’t want to risk the roof over your head in any way whatsoever. You borrow the money and you pay it back in instalments – it’s as simple as that.
Interest Only Mortgages
With interest only mortgages, your initial monthly payments to your lender are just interest. You don’t pay off any of the capital at all during the interest only period. However, be aware, mortgage lenders are obliged to insist you switch to a capital and interest mortgage at a later date, usually 5-10 years into your mortgage term to ensure you pay off your home loan at some point. Whilst you could in theory re-mortgage at this point to an alternative lender and pay interest only for another 5-10 years, it is not a recommended route as you may find yourself paying back your home loan until the day you die.
Many interest only mortgages are set up this way to reduce initial mortgage repayments, switching to a capital and interest mortgage after 5 or 10 years. A worrying trend is the growth in the number of interest-only mortgages where people are making no separate plans to repay the capital element and continue to re-mortgage to an alternative provider to maintain an interest only home loan. Instead they’re relying on house prices to rise sufficiently so that they will be able to trade down to a smaller property, using the difference to pay off the mortgage. This is an extremely high risk approach and not one that should be recommended, what are you going to do if there’s not enough equity in your home?
If you feel you can’t afford repayments on a home loan on a principal & interest basis, then you can’t afford it. You could find a small increase in interest rates blows your monthly repayments out of the water!
