Fundamental Fact Guide On Uk Mortgages

By Author: Lucy Carter
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For the average person, it's certainly not easy getting your head around mortgage financing - since jumping on the property ladder is a major and long term investment; the following guide has been designed to help you get to grips with the basics.

In a nutshell, a mortgage entails borrowing an agreed sum of money from a building society or bank to finance the buying of your first home. You then pay back this loan plus interest over a fixed period of time.

There are various ways and packages to do this. The bottom line is that there are two main ways to finance the property of your choice:

Repayment Mortgage - Capital & Interest

Similar to repaying your credit card debts, this option entails you repaying in monthly instalments the full or capital amount you borrow together with interest calculated on top,. Your mortgage statement will generally be received annually, with the outstanding balance you owe obviously decreasing during the length of your repayment term.

Pros & Cons

The benefits of a straightforward repayment plan are that at the end of the agreed term you will have ...
... repaid the amount you borrowed in full. The added cost of life insurance is not always necessary with this type of arrangement and often (depending on the lender) you can make lump sum payments and overpayments into your mortgage account to reduce your capital debt and thus your interest.

The disadvantages are that if you choose not to take out life insurance and die before your mortgage loan is repaid, the debt will still be owed and your relatives might have to sell the property to settle it. Another factor is that your loan provider could charge penalties for making overpayments /lump sums into your mortgage account, so when shopping around for a mortgage make sure to find out their fees for this. Also bear in mind that a majority of loan providers take your monthly repayments to cover a large portion of the interest first before you start truly chipping away at the capital loan itself.

Interest Only Mortgage - ISA, Pension or Endowment

As per its title, with this type of mortgage means your monthly repayments only cover the interest charge set by your lender, the capital lump sum is not addressed. The way this works is that to cover the payment of the capital loan you will have an alternative 'repayment vehicle', which will be an ISA, an endowment or a pension plan.

Endowments

These are the most common of this type of mortgage. They include life insurance cover so that in the event of death your mortgage will be paid. The key scenario with endowments is that you make fixed investment payments with the idea that when your mortgage term is finished they will pay for your capital loan in full. These fixed payments are calculated on the amount of your capital loan together with the mortgage term you select. Once very popular in the 60's and 70's, they subsequently received bad press because poor investment growth rates in a low inflationary economy meant that when endowments matured the amount invested and earnings were not enough to pay for the capital sum. They are however still used for mortgage payments by millions of borrowers. Endowments can still be of significant benefit, but you are strongly advised not to cash them in early - by cashing-in your endowment policy in the first few years you could receive less than the amount you originally invested.

ISA

An Individual Savings Account (ISA) is a tax free way of saving your money. Because of their financial complexity however, to really be on solid ground with this option you need to be financially savvy or take on a sound financial adviser.

Pension Plan

With this choice, your monthly repayments will be made into a pension fund and you'll also get life assurance cover. When the pension plan funds are eventually released, they will pay off your mortgage capital debt using tax-free cash. You can then draw a pension from the remainder of the fund amount. This package is popular with the self employed but you're advised to use a financial adviser to help you keep on track.

Pros & Cons

The advantages of interest only mortgages is that they're highly tax efficient and if the proceeds of your investments exceed the amount required to repay the mortgage, you'll receive a tidy lump sum in addition to paying off your home.

The drawback however is that if your repayment vehicle proceeds don't achieve the capital sum you owe then you will be in trouble. It's thus very important to keep a vigilant eye on your policy fund to make sure it's keeping pace. If it's not, a solution could be to increase your payments into the policy or find another investment to cover the shortfall. Another issue is that paying off these types of plans early can incur financial penalties.

If you're inexperienced but interested in first time buyer mortgages, the above guide will help you understand the fundaments. What is crucial is to always do your research thoroughly so that you can find the financing deal that best suits your needs.
Sean Raston is an economics student and expert in first time buyer mortgages.