FISCUS MORTGAGES - INFORMATION AND ADVICE

Interest-Only Mortgage

With an interest-only mortgage, each monthly repayment is used to pay off the mortgage interest only. The repayments do not pay off the capital that is owed on the property. Lenders will usually prefer the borrower to put an “investment vehicle” in place, ensuring the accumulation of monies for payment at the end of the term, although dependent on circumstances, some mortgage providers will be prepared to let the borrower take out an interest-only mortgage without an investment that will repay the loan. After all, the property can be sold at the end of the term if the borrower is unable to repay the mortgage capital.

INVESTMENT VEHICLES

Alongside the interest repayment, the borrower will take out some kind of “investment vehicle”. This may be an endowment policy, a pension plan or possibly an Individual Savings Account (ISA). The borrower pays money into this investment alongside the interest repayments, and as this investment builds over the lifetime of the policy, at maturity, it should pay off the mortgage capital.

The single biggest problem with this type of mortgage is the risk inherent in the investment vehicle. If the investment under-performs, then the investment may not be enough to pay off the outstanding capital at maturity. The flip-side, of course, is that the investment may perform better than expected and there would be a resultant windfall at maturity. If this is the case, then the policyholder gets to keep the balance after the mortgage has been repaid.

ENDOWMENT POLICES

The most popular investment vehicle for an interest-only mortgage is an endowment policy. These policies have received widespread negative press attention over the past few years, first for the miss-selling scandals of the late 1980s and more recently because of the troubling performance of life companies such as Equitable Life and Friends Provident over the past few years.

Endowment payments are invested by life companies into large funds, used to purchase shares and bonds. As the stock market faltered early this millennium, many policyholders saw the value of their policies fall. This has seen a fall in take-up of new endowment mortgage policies, as consumers have accepted the inherent risk involved in such policies. To counter this, many life companies have now shied away from share investments, opting for more stable investments such as bonds (although the lower risk translates into a lower return on investment).

Endowment policies include life assurance as standard, ensuring that the mortgage is paid in full in the event of the untimely death of the policyholder. Life companies will also offer life assurance on its own for all types of mortgage consumers, and at maturity, will often make a small payment to the policyholder.

Should you remortgage at any time, by switching your mortgage provider in favour of better terms offered by a competitor, the endowment can continue uninterrupted and be paid to the relevant financial institution upon maturity. However, as you are not repaying the mortgage capital in the fashion of a repayment mortgage, some individuals choose to gain short-term funds by “cashing in” (surrendering) their endowment. There are strong penalties attached to this, and in the early years of the policy, the surrender value is frequently less than the amount paid into the policy.

It is also important to clarify the three major types of endowment policy:

With Profits Endowment
The endowment lasts for the same term as the loan and a sum is assured of equal value to the loan, thus guaranteeing full repayment of the mortgage from the beginning. Provided all premiums are paid, then upon maturity, the investment repays the loan and there will be a remainder (reversionary and terminal bonuses) that belongs to the borrower. However, this type of mortgage is very expensive, and is now quite rare.

Non Profit Endowment
Like the with profits endowment, the sum assured is equal to the value of the loan, effectively guaranteeing repayment of the mortgage. However, there is no bonus payment to the borrower on maturity, and is these are also an expensive type of mortgage, it is rarely used.

Low Cost Endowment
This is the same as a With Profits endowment, however the sum assured is of a lower value than the loan. It is set at a level whereby, upon maturity, the reversionary and terminal bonuses will also go towards repaying the mortgage. This means that there is no guarantee of the investment vehicle paying off the mortgage, as there may be a shortfall with bonuses. However, assurance for the term of the mortgage starts at the full value of the loan and slowly falls over time. This assurance covers the difference between the value of the endowment and the loan, ensuring the full mortgage value is paid upon death of the borrower during the term.

INDIVIDUAL SAVINGS ACCOUNT (ISA)

Although endowment policies are the most popular interest-only related investment vehicle, there are other options. Using an Individual Savings Account (ISA) provides a tax-free vehicle for savings. However, an ISA has a cap on the amount that can be invested annually, so can only really be used to supplement an existing investment vehicle, or for particularly small mortgages. For some people facing a shortfall at maturity of their existing endowment policy, investing in an ISA as a secondary payment vehicle may make up this shortfall. To set up an ISA, as with all options, it is best to speak to an Independent Financial Adviser (IFA) before deciding on an investment strategy.

PENSION POLICY

Some individuals will opt to link their mortgage capital repayment to a pension policy. They make monthly payments into a pension fund. When the pension finally is drawn upon, a lump sum is withdrawn from the fund to pay off the mortgage. The remaining balance is then used to provide a pension to the individual. Money owed on a mortgage that is repaid from a pension plan is typically tax-free. This option is particularly popular amongst the self-employed, but due to the complex nature of this financial product, it is again recommended that you speak to an IFA before making your decision.

As with all financial products, we recommend that you seek advice from a trained professional before making your decision. Please fill out our brief enquiry form and we will have an Independent Financial Adviser (IFA) contact you within 24 hours.