Capital & Interest
A capital and interest mortgage, works the same way as most types of loan. You make regular monthly repayments to the lender; the repayment is made up of capital (repaying the amount you initially borrowed) and interest. Provided you keep up the correct payments, at the end of your mortgage term you will have repaid the loan in full.
The longer the period you borrow over, the more interest that you will pay overall. This is also true of Interest Only and Split mortgage described below.
With an interest only mortgage, as the name suggests, you only pay the interest charged by the lender. This means you need to some way to save the money to pay off the capital at the end of the term. There are a few main ways to do this:
- Endowment policies
- Pension plans
- Other Investments
- Lump Sum Overpayments
- Sale of Property in the future
Most investment vehicles used to pay off the loan are not guaranteed to make enough money to do so. This could mean that there is a shortfall and you would therefore still have a debt outstanding at the end of the term.
There are other ways in which you could repay an interest only mortgage i.e. if you were buying a property to let out, you could sell the property at the end of the term and repay the mortgage that way. Additionally some lenders will allow you to take an interest only mortgage (without repayment product) and convert it to capital and interest at a later date.
Since the Mortgage Market Review in April 2014 the ability to take an interest mortgage has been severely limited as it was felt that too many mortgages being taken had inappropriate or unrealistic means to achieve full repayment.
The exception to this is Buy to Let mortgages where interest only is fully accepted by the lenders.
Sometimes lenders allow you to combine both repayment methods.