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From The Times

March 20, 2007

A guide to mortgages

Grainne Gilmore

Interest-only mortgages

Homeowners who choose these deals repay only the interest on their loan without making a dent in the capital. More and more borrowers are choosing this option. The advantage is clear: interest-only deals are cheaper than repayment loans, so borrowers have more cash left in their pocket each month. The monthly cost of a repayment mortgage (repaying capital as well as interest) on a £250,000 loan fixed at 5.5 per cent is £1,535. Interest-only payments are nearly £400 cheaper at £1,145 a month.

But choosing an interest-only deal is risky. When the mortgage term is over, borrowers must either be able to stump up the outstanding capital sum from other investments, or rely on selling their home for at least as much as they borrowed, if they are to avoid a shortfall.

Offset mortgages

Offset mortgages allow borrowers to use their savings and current account to offset the cost of their home loan. Instead of receiving interest on their savings and current account, borrowers can save on the interest they would pay on their home loan. A couple with a £200,000 home loan on a £250,000 house will pay £1,245.14 a month on Intelligent Finance’s Offset 90 mortgage. This is costlier than the current best buy fixed-rate home loan deal of 5 per cent, which would mean monthly payments of £1,169. But by taking into account the couple’s savings of £20,000, a further £3,000 in tax-free savings and a monthly deposit of £4,000 a month into their current account with IF, they can shave more than £60,000 off the interest and repay the loan 4 years and 9 months early. But offset mortgages are only really worthwhile for those with savings, and people now save only half as much as they did ten years ago.

Extending the mortgage term

One way to cut the cost of repayments is to exend the loan term from 25 to 30 or even 50 years. Extend the term of a £200,000 loan at 5 per cent from 25 to 30 years and the repayments fall from £1,169 to £1,073, saving more than £1,000 a year. But while the repayments fall, borrowers have to pay interest for an extra five years — which will add thousands to the total cost. The total amount that a borrower will repay on the 25-year deal is £350,754. Extending the term by five years will add about £36,000 to this. Mortgage brokers advise keeping mortgage terms as short as possible.