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| How different mortgages work |
If you are confused by the jargon surrounding mortgages, you are not alone. Many first-time buyers don’t know the difference between an annuity and an endowment mortgage, not to mention the more recent interest-only mortgage, until they start shopping around.
But if you don’t want to be at the mercy of some smooth talking less-than-honest adviser, you should understand how the main categories of mortgage work and which would best suit your needs.
A repayment/annuity mortgage
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This is the most popular type of mortgage and works in much the same way as a personal loan except the term is much longer. The capital borrowed is repaid monthly along with the interest traditionally over 20 years. However, 25 and 30 year mortgages are now the norm for first time buyers. Inflated property prices mean they have to extend the term of their loan in order to afford the monthly repayments. About 90% of Irish people choose a repayment/annuity option.
An endowment mortgage
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Payments are made on the interest owed each month. None of the capital amount borrowed is paid off during the term of the loan. Instead a further monthly contribution is made into an investment fund which is usually put to work in the stock market, with the objective of achieving sufficient investment growth to pay off the capital borrowed by the end of the mortgage term. The problem with this option is uncertainty. You are not guaranteed that your home loan will be paid off by the end of the term.
The sales pitch states that when you cash in the endowment policy at the end of the mortgage term, there should be enough in the investment fund to pay off the entire mortgage as well as giving you a lump sum to enjoy. However, in may cases quite the opposite has happened. There has being huge controversy about this type of loan in Britain, where hundreds of thousands of home-owners found themselves owing large sums of capital at the end of the mortgage term. Investment growth was not sufficient to pay off the capital owed and homeowners ended up owing chunky amounts of capital to their lenders.
Mortgage advisers believe that about two to three per cent of people choose this option.
A pension mortgage
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This is similar to the endowment mortgage except that a monthly contribution is paid into a pension plan instead of an investment fund to pay off the mortgage. It is tax efficient as you can claim income tax relief at the standard rate of income tax (20 per cent) on the interest payments and the top rate of 42% if you are a higher rate tax payer on the final pension fund. However, it is only suitable for a small percentage of people who are usually self-employed, company directors or high earning managers. Around 2 to 3 per cent choose this option.
An interest only mortgage
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The concept is simple, you don’t pay off your mortgage, you just pay the interest until such time as you can pay off the original loan amount itself. However, this is a classic case of buyer beware.
Only about 1 to 2 per cent of first-time buyers opt for such a mortgage, according to industry sources. Interest-only mortgages are not for everyone and probably especially not for younger first-time buyers who may not be in a position to pay off large lump sums over the term of the mortgage.
Bank of Scotland, ICS and First Active offer such loans. The sales pitch is usually aimed at those who may know they will receive an inheritance or cash windfall in the future from invested share options, large bonuses or a cash lump sum from their pension fund. Some commentators believe these mortgages are more attractive to older people who have accumulated more assets and are better equipped to pay off the original capital amount borrowed.
A split rate mortgage
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This offers customers the option of having some of the mortgage set at a fixed rate and the remainder at a variable rate. For example, a 50/50 split – 50% at a variable rate and 50% at a fixed rate. You can choose a 60/40 split and son on. Split mortgages are a good way to manage your exposure to interest rate movements.
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