Capital and Interest Mortgage

These are also known as capital repayment mortgages. Capital is paid back gradually every month and, at the end of the term, assuming the borrower has kept up the repayments, the loan is guaranteed to be paid off. If interest rates remain the same for the term of the loan (which is unlikely) the monthly repayment stays the same.

At the beginning of the loan term, interest is charged on the full amount of the loan and the monthly repayments are mainly interest charges and very little capital is repaid. As the loan progresses, however, and more capital is repaid, the interest is charged on a steadily decreasing amount and the proportions of interest and capital shift. In the later stages of the loan, the repayments are mainly capital repayments and the final payment will pay the final amount of capital owed and the last interest charge on it.

All of this assumes that the borrower survives to the end of the term. If they died during the term, the outstanding balance of the loan would be a debt to the estate. In the likely absence of funds with which to repay the debt, the lender would exercise its right of sale of the mortgaged property and recoup the monies owed from the proceeds. This, of course, would be devastating for any surviving family who would have to vacate the home. Life assurance covering the death of the borrower during the term is therefore necessary in order to ensure that the mortgage can be paid on early death.

Any type of cover producing enough money on death would suffice, but the most appropriate (and least expensive) is a decreasing term assurance which reduces in step with the outstanding loan, provided there are no arrears. This type of contract (often called a mortgage protection policy) guarantees to provide the required sum on death, assuming interest rates do not exceed a certain percentage. Clearly, if interest rates were to be significantly higher than those assumed when calculating the premium, then the loan would decrease at a slower pace than the decreasing term assurance (unless payments had been increased proportionately) and cover may not be adequate.

Summary Points:

•  Capital repayment mortgages guarantee that, if repayments are kept up, the loan will be repaid by the end of the term.

•  As the term progresses and the loan is repaid, equity builds up in the property at a faster rate than under the interest only method. There is, therefore, less likelihood of negative equity being a problem using this method, or, if it does occur, it is likely to be a slightly smaller problem. As the capital is repaid slowly in the early years however, this advantage is likely to be marginal.

•  As the equity is greater, the loan required when the borrower moves is likely to be less as there is more profit from the sale of the previous house. There is, therefore, likely to be less need or no need for a higher lending charge for the next mortgage.

•  If the borrower runs into financial difficulties, the lender may allow them to pay interest only for a period, cutting down immediately the monthly cost.

•  Repayment mortgages tend to be flexible in respect of changes in the term of the mortgage. The lender may agree to an extension to the term, which reduces the monthly repayment.

•  Repayment mortgages may be a preferable option for more elderly borrowers where the cost of an endowment policy may be too high.

•  Where there are dependants, life cover needs to be added in to protect against death during the term.

•  There is no prospect of a lump sum being available to the borrower at the end of the term

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