Mortgage Payments Explained
Mortgage Payments
Most mortgage payments consist of two parts:
- repayment of the amount you borrow, and
- interest
Interest usually forms the greater part of mortgage payments, so the way interest is calculated can make a big difference to how much it costs. In fact, over the life of a typical mortgage (say, 25 years) the interest can be as much as twice the amount you borrow, even more in times of high interest rates. There is a separate article describing how interest (mortgage rates) are calculated. This article focuses on the repayment component of mortgage payments.
There are five common options for repayment of the amount you borrowed:
1 - Endowment
Endowments are combined investment and life insurance policies. You pay a regular amount of money into them, your money is invested and, at the end of the policy, it pays you back the growth resulting from that investment.
Because the final amount is unknown, there is a risk with Endowment Mortgages: the final sum you get back may be more, or less, than the money you originally owed. If it is less, you will have to find the remaining money from alternative funds.
2 - Repayment Mortgages
The money you owe on Repayment Mortgages is paid back in monthly instalments so that, by the end of the mortgage, all the money you owe is paid off.
3 - Interest Only
The money you owe on Interest Only Mortgages is not paid back at all (at least, it is not included in the monthly payments). You leave the same amount of debt outstanding for the duration of the mortgage.
In such situations you will have an alternative plan for paying off what you borrow. For example, there are particular types of interest only mortgages called "bridging loans". These enable you to buy a second house whilst you have not yet sold the one you currently own, so that you can renovate the second house and then move in. You only repay the money owed on the bridging loan once you have sold your first house, using the money you get from that sale.
4 - ISA
An ISA is a special savings or investment account that qualifies for tax relief. You pay a regular amount of money into the ISA, the amount you have saved is invested, and the value of the ISA is used at the end of the mortgage to pay back the money you borrowed.
As with Endowment Mortgages, the final amount of the ISA fund is unknown, so there is a risk that you get back more or less than the money you originally owed, with the possibility that you may have to make up a shortfall.
5 - Pension
Pension mortgages are similar in principle to ISA and Endowment Mortgages: you pay money into a fund, which is invested, and at the end you get a lump sum that is used to pay off the mortgage. In this case, you pay money into a pension fund.
However, the amount of money that you can pay into the fund, and draw off at the end to pay off the mortgage, is governed by a different and much more complex set of rules to ISAs and Endowments, because it is a pension scheme.
Summary
The types of mortgages available are defined, in general, by the way the money is repaid, and how interest is calculated.
Money can be repaid by one of the following methods:
- Endowment
- Repayment
- Interest Only (ie no repayment)
- ISA
- Pension
There is another article describing how mortgage rates are calculated, ie: the second component of the monthly payment, interest.
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