A repayment mortgage is a term generally used in the UK to describe a mortgage in which the monthly repayments consist of repaying the capital amount borrowed as well as the accrued interest, so that the amount borrowed decreases throughout the the term and by the end of the loan has been fully repaid.
This contrast with a interest only mortgage where monthly repayments are for interest, and the borrower must repay the full loan at the end of the term in a lump sum.
There are destinct rules in the UK when purchasing home, and the banks will no longer accept interest only payments. This is primarily due to the problems in the past with endowment mortgages for example, where individuals simply did not understand or have explained to them the investment nature of an investment of this type and the subsequent risk of the investment, not being worth enough on maturity to repay the mortgage loan.
However, for property investors 'interest only' mortgages remain available. This is for a number of reasons, not least, that it is believed that if an individual is investing in property, then they will have made certain they understand the options and the risks.
With property investment, the individual should at all times remain in control of their cash and that as this purchase is an investment in a 'house' and not the purchase of a 'home', the entry into property investment, should always be with a exit in mind. Therefore when selecting an investment property, the key consideratio
n is who you will sell this property to.
The intention with property investment is usually sell at some point in the future, with some investors this can be as short after refurbishment works demonstrate an increase in value. For our clients the sale is usually:
- Before returning to the UK
- When children start university
- At retirement
- Through transfer to children as part of Estate Planning
Therefore a sale is always in mind but will not impact the investors living arrangements, precisely as investors do with a portfolio of stocks and shares.
The property market moves in cycles, as do equities, but a slower pace and with a slower pace and with lower volatility ratio ordinarily, therefore it tends to be a planning exercise to exit property rather than a market timing exercise (think buy low / sell high).
So consequently the mortgage repayment will usually come from a sale and not at the end of the term of the mortgage and therefore the advantages of interest only v capital repayment can be considered differently for an investor vs a home purchaser.
Repayment Mortgage Advantages
- Lenders prefer them
- Your Loan value decreases each year
- Your equity grows each year
Repayment Mortgage Disadvantages
- The monthly payment is more expensive
- The rent is unlikely in most cases to be higher than the repayment each month
- Any shortfall each month is your responsibility
- You are unlikely to be able to switch from Repayment to interest only in the future, if you struggle with a empty period in your property for example
- If the investor were to get into financial difficulties and the property was repossessed, the bank will always look at simply recovering its loan, they are not concerned about your equity, so your equity could be lost if not in full then at the least part
Interest Only Mortgages Advantages
- The monthly payment is lower for the investor
- The rent is likely in most cases to be higher than the repayment each month, therefore surplus can be banked and used for maintenance or savings
- Your lender will allow you to switch from interest only to Repayment quite willingly at any point
- You can pay lump sums off the mortgage if you wish, but if you were to get into financial difficulties and the property was repossessed, the bank will always look at simply recovering its loan, they are not concerned about your equity
Interest Only Mortgage Disadvantages
- The loan balance never reduces year on year
- Your equity grows with the property only and not with the debt reduction Lenders will only allow investors to lend this way, not home owners.