2.1.2 Interest Only Mortgage
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Unlike the repayment mortgage, only interest is paid to the lender
with this method.
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The loan is repaid at the end of the term by cash taken from a
suitable product which has run alongside the loan from commencement.
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Consideration needs to be given to adequate provision of life assurance.
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The repayment vehicle, depending on the type, may offer the opportunity
of early repayment if growth of the investment element reaches the
loan value before the end of the term.
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A suitable repayment vehicle may be one of the following:-
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Endowment policy, where repayment is guaranteed
on death provided the guaranteed sum assured matches the
outstanding debt. For the full endowment, repayment is guaranteed
also at maturity, but for with profits, low cost and low
start endowments there is no additional guarantee, as growth
depends on non guaranteed bonuses. Details of these policies
can be found in Savings and Investment
.
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Pension policy, where repayment is from the tax
free retirement cash sum. Repayment on death is from a life
assurance policy linked to the pension, whilst repayment
at the end of the term relies on investment performance.
The main disadvantage with this method is that repayment
from the policy can take place only on retirement, which
at its earliest is 50, and cash and pension must be taken
together in most circumstances. Additionally such a policy
is only suitable for those who qualify for an EPP or PPP/Stakeholder,
as group occupational schemes are not usually linked to
such loans. More details of pension policies can be found
in Pensions.
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Collective Investments, where unit trusts, investment
trusts and similar vehicles can be utilised as a method
of providing funds at a future date to repay a mortgage.
It would be prudent to take a conservative view in terms
of potential growth assumptions as of course there are no
guarantees regarding the eventual return or when the investment
would equate to the amount borrowed. Choice of fund(s) similarly
would need careful consideration. Given that the purpose
of such an arrangement is redemption of a mortgage (and
therefore home ownership) it is essential that prospective
borrowers understand and accept fully the associated risks.
Appropriate life cover would be an additional consideration
and cost. Ultimately it is for the lender to decide if such
a method of repayment is acceptable or otherwise. PEPs proved
to be a popular method of mortgage repayment because of
their tax free status (despite the investment risks). However,
since 6 April 1999 borrowers have needed to turn to an alternative
investment (or mortgage) as no new monies could be invested
in PEPs since that date.
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ISAs may prove attractive to some borrowers but
as with PEPs they need to be aware of the inherent investment
risks (non cash ISA) and the maximum contribution limit
may be a detriment to very large amounts loaned or short
term mortgages. Also, the government has stated that the
continuance of ISAs will be reviewed in 2009 - what of the
future? Again, appropriate life assurance will need to be
considered
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