Making Sense Of The UK Mortgage Minefield

Yes, you've got to know what you're doing because it's a mortgage minefield out there. So tread warily! A quick pointer or two may help you navigate safely through to the other side.

Don't confuse products and repayment methods. Despite all the thousands of products on the market in the United Kingdom - and they come in all shapes and sizes - there are only two - yes TWO - repayment methods. They are capital repayment (often referred to as capital and interest), and interest-only repayment. That's it.

Some 30 years or so ago, capital repayment was the usual way of repaying back a mortgage loan. But the popularity of this repayment method gradually fell in favour of its more fashionable interest-only cousin. However, capital repayment has made a bit of a comeback over the last few years.

So what is capital repayment? You know that lump of cash you work so hard for and which you hand over every month to the mortgage company to pay back the loan? A bit of that cash is actually used to repay some of the money you've actually borrowed. And the rest of the monthly repayment goes towards the interest on the sum borrowed.

At the beginning of the mortgage, only a small percentage of each repayment goes towards the capital. But during the final few years, more and more goes towards reducing the capital and less and less towards paying interest.

If every repayment over the life of the mortgage has been paid on time then at the end of the agreed term (for example, 25 years), the sum borrowed should have been paid back in full.

Now compare the above situation with the interest-only repayment method. Pound-for-pound borrowed, it is much cheaper than a capital and interest mortgage. That's because the WHOLE of the monthly repayment goes towards interest on the sum borrowed. No part of the repayment is used to repay the original capital borrowed, which remains outstanding until the end of the mortgage term.

But here's the rub. An investment vehicle, running alongside but completely separate from the mortgage, is used to pay off the loan at the end of the term. Some of the commonest repayment vehicles are low-cost with-profit and unit-linked endowment policies. Unfortunately, many endowment policies taken out a number of years ago have underperformed, to the point where borrowers have been left with a cash shortfall at the end of the mortgage term. Hence the declining popularity of interest-only loans.

The good news is the UK's financial watchdog, the Financial Services Authority (FSA), has bared it's teeth and now endowment providers have to produce a review of every plan, providing policyholders with an illustration of maturity values based on annual growth rates of 4%, 6% and 8%.

If a growth rate of more than 6% is required in order to pay off the mortgage, the policyholder must be advised that some form of action has to be taken. A 'red' letter indicates high risk and therefore strongly recommends the policyholder take some action; 'amber' indicates significant risk and recommends some form of action if the policyholder is concerned; 'green' indicates the policy is on track.

John Donaldson is a fully qualified CeMAP mortgage advisor and runs http://www.mortgageadvice4free.co.uk/ and http://www.freebieads.co.uk/ in his spare time.

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