Under this type of mortgage all you pay to the mortgage
company is the interest accumulated on the debt.
Due to this fact the mortgage balance remains the same
as it was
when the original advance was made, for example if you
borrowed £75,000 under an interest only arrangement then
after 25 years £75,000 will still be outstanding. This
can be clearly seen in the diagram below.
Please note the graph below is not accurate and is for
illustrative purposes only.
As only interest is being paid to the mortgage company
and the debt is not reducing there is also a need to
make some sort of provision to repay the debt at the end
of the mortgage term. It is for this reason that
endowments came about. However endowments are not the
only plan that can be used with the aim of repaying an
interest only mortgage, anything capable of producing a lump sum
equivalent to the outstanding debt is capable of being
used as a repayment vehicle such as an ISA or even a
pension. Some people use the prospect of money coming to
them in the future, such as an inheritance, as a
repayment vehicle for an interest only mortgage. Caution
should recommended in this situation as life has a habit
of changing and to put the plans of repaying a large
debt into the hands of a potential inheritance can be
considered foolhardy.
It should be noted that with any investment related
repayment vehicle, investments can go down as well as up
and you may not get back the full amount invested. There
is also no guarantee that the investment taken out will
be sufficient at the end of the mortgage term to repay
the mortgage.
Again as with the repayment mortgage the interest only
payment that is made to the mortgage company is not
necessarily the only thing you will need to be paying,
you could and probably should, be paying in addition,
buildings and contents insurance and life cover.
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