Repaying Your Self Certification Mortgage

A mortgage loan is likely to be the largest single credit agreement that you take out.

One of the important decisions to make is how your mortgage will be paid off.

The choice is between “interest only” or “capital and interest”.

Capital and interest basis;  Each mortgage payment consists of mortgage interest plus a small repayment of capital.  The capital balance reduces over the course of the mortgage down to zero at which point your mortgage is cleared.

You can arrange your mortgage on an interest only basis.  You just pay the interest back to the lender.  This will minimise your mortgage payments but the capital is not being repaid.  How will you clear your mortgage with an interest only mortgage?

Some people will save regularly into ISAs or endowment policies and over the term of a mortgage will expect that their savings will exceed the mortgage balance.  Of course, there is not guarantee of this and the adverse publicity surrounding endowment policies mainly centres on them not fulfilling their objective of not replaying the mortgage.

ISA stands for Individual Savings Account.  ISAs are tax free accounts inside of which you can keep a range of investments.  The range of investments will depend upon your attitude to risk.  The plan here is for your investments to grow over time and to clear your mortgage at some time in the future.  The safer the investments the more cautious the investment returns tend to be. You should discuss this option with an Independent Financial Advisor.

Endowments.  These are investments that include life assurance.  They attract bonuses annually that accrue steadily.  Because of their steady growth they are regarded as a lower risk investment. But as reported in the press recently, adverse Stock Market performance has caused some of these investments to under perform. Again you should discuss this option with an Independent Financial Advisor.

Pension.  A stakeholder or personal pension can be used to clear a mortgage.  On retirement you can draw up to 25% of your pension as a tax free lump sum.  You can use this lump sum to clear your mortgage.  One of the principal advantages of using this method is the tax relief which everyone receives on their pension contributions.  For example, for a higher rate tax payer, this means that for every £60 put into the pension.  The tax relief allowed means that £100 actually is credited. 

One disadvantage of this method is that you can only draw your tax free lump sum when you draw your pension. Drawing money from your pension will reduce the pension payable to you. You can draw up to 25%.  There is no guarantee that your pension pot will be sufficient.

Interest Only.  Some people choose interest only as a means of keeping their mortgage affordable.  This might be acceptable as a temporary solution for a young person, but is not a long term solution.  While inflation will reduce the debt so that it “feels” smaller, the debt will still be there.  Most people’s income will drop dramatically at retirement and it would be sensible to have cleared your mortgage by this time.

Term.  It is usual to choose a term of 25 years for a mortgage.  You can choose a shorter or longer period.  If you reduce the term of a Capital & Interest mortgage, your mortgage payments will rise.  If you extend the term your monthly payments will fall.  This is because you are paying off the capital sum over a shorter period.  If you choose an Interest Only mortgage, the term will make no difference to your monthly payments as you are only paying the interest.