Interest Only Mortgage

Interest only mortgages allow you to pay interest only. Your capital is not reducing so you are not actually paying the loan - only the interest.

You have to make other arrangements to pay off the loan itself. That could be by means of an endowment insurance, though they have had bad press lately because if growth is less than calculated you could end up not having enough to pay the mortgage principal. You could also take a pension policy, or intend to use the lump sum option of your pension when you retire.

It is extremely important with an interest only policy, that you keep an eye on the growth of your investment. If share prices drop, or the country enters a recession, you have to consider other options to pay off the loan or you could lose your house. This is not a recommended way of repaying a mortgage, but some choose it because a) it allows lower repayments and they believe that they are better paying the principal amount into their own investment, and b) they know they have a lump sum coming from, for example, an inheritance or secure pension.

Unless you are in a strong financial situation you will not be given such a mortgage. They are popular with property investors and developers, and the ordinary borrower is safer with another type of mortgage. However, if you decide to go this way, there are two basic types of interest-only mortgages on offer to you: the endowment mortgage and the pension mortgage. The latter first:

Pension Mortgage

A Pension Mortgage is intended for those that are unable to take part in an occupational pension plan: people that are self-employed or are debarred from a works pension scheme for some reason. The mortgage is paid off when the pension policy is cashed in. Until then you pay interest only and another sum into a personal pension investment plan.

The problem with this is that the pension plan has to grow at the estimated rate, so that it not only pays a pension but also pays the mortgage capital. If growth is less than expected you could be in trouble.

Endowment Mortgage

This works in a similar way to the Pension Mortgage, only rather than a personal pension plan, you are paying into an endowment insurance policy. This is also expected to increase in value over the period to enable the loan to be repaid in a lump sum.

This again is not guaranteed and the Endowment Mortgage offers the same risk as the Pension Mortgage plan. There is one factor in your favour however: the principal sum is subject to a reduction in real value with inflation, and that is the general trend over the longer term. Hence, the longer the term of such a mortgage, the less in real cash value on the day you will have to repay.

If it appears, however, that there will be a shortfall between what you have to repay and the value of your policy, then you can:

• Increase the amount of your payments to the policy,
• If you can afford it, pay off a lump sum to reduce the capital, and hence the interest also,
• Cash in the policy, pay off that amount of the mortgage, and then renegotiate a repayment or annuity mortgage to pay interest plus capital each month,
• Increase the term of your mortgage to give you more time to make up the shortfall, and
• Get some professional financial advice.