Mortgage Advice

Interest Only Mortgage

The main advantage of interest only mortgages is that the initial monthly payments are much less than that of a regular fixed or variable interest rate mortgage. The major downside to an interest only mortgage is that once the initial ‘interest only’ portion of the mortgage agreement expires, the monthly repayments shoot up to cover both the interest and the principal. So for a 30 year mortgage with a 5 year interest only plan, the borrower pays monthly instalments to cover the interest only for the first 5 years, but then has only 25 years to pay off the entire amount of the mortgage. If that same borrower stayed with a regular mortgage, they would have the whole 30 years to chip away at the mortgage.

Interest only mortgages are primarily geared toward those people for whom getting onto the real estate ladder is quite difficult, or for those who have short term property goals and who believe that the capital gain of the property justifies an interest only mortgage.

Endowment Mortgage (also Interest Only Mortgage)

With an endowment mortgage, or interest-only mortgage, the payments you make to your loan provider are to cover the interest only not the principal. This means that despite making payments to your mortgage provider each month, the actual loan amount doesn’t decrease. Your other obligation, under this type of mortgage, is to make payments into an endowment or investment company. These companies will be authorised by your mortgage lender, and you will be responsible for ensuring that the investment provides sufficient funds at the end of the mortgage term to pay off the original loan amount.

Endowment mortgages can be extremely risky as essentially you’re betting that the money that you pay into your investment portfolio will have sufficient funds in it by the end of the mortgage term. As nothing in life is certain, it stands to reason that taking out this kind of a mortgage is somewhat of a gamble. One only has to look back at the economic changes over the last 20 or 30 years to realise that circumstances can, and do, change. With an endowment mortgage you essentially have two distinct areas of concern – that the interest rates won’t rise dramatically, thereby increasing your monthly payments to the lender, and that the economic outlook remains favourable, thereby keeping your investment portfolio on track to pay off the outstanding amount at the end of the term. Of course, there is always the possibility that a well managed investment portfolio will generate far more income than that which is required to pay off the mortgage, but the opposite is also true.

If, in the situation that the borrower’s investment portfolio doesn’t mature with enough funds to cover the original mortgage amount, the borrower still has some options available:

• For the projected shortfall, the borrower can switch from an endowment mortgage to a simple repayment mortgage. There will however be associated costs and fees for doing this.

• Adjust either the payment amounts or the length of the term of the endowment mortgage if allowed. By extending the term, the borrower has extra time for the investment portfolio to reach its goal – but of course, interest payments will still need to be made to the bank. By increasing the monthly payments to the investment portfolio, the chance is being increased that the target goal could be met on time.

• Make up the shortfall with funds from elsewhere if possible, for example, by borrowing additional money from other lenders etc.

No matter which option a borrower chooses, they should be extremely careful in adding up all of the extra costs, fees and interest charges to ensure that their money is going to where it needs to be going, and that’s paying off the mortgage.