Repayment Mortgages
A repayment mortgage is the simplest type of mortgage. You borrow, say, £50,000 and each year pay back interest on the loan and a little bit of the capital that you borrowed in the first place. Consider the following examples. (Both examples are simplified. In reality the way that annual percentage rates are calculated would mean that the actual payments would be somewhat different.)
Example 1
A £50,000 loan is made over a term of 25 years.
- This means that on average each year the capital repayment is £50,000 ÷ 25 years, ie £2,000 per annum.
- On top of this interest is payable at say ten per cent.
- Thus in the first year the payment is £5,000 interest
- £2,000 capital repayment
- Repayment £7,000 total
The problem is that a repayment mortgage does not work like this. In order to keep the mortgage payments down in the first years, the mortgage lender reduces the amount of capital that is repaid in the early years of the loan. As the loan decreases, the amount of interest payable each year decreases, and a larger percentage of the repayment becomes available to repay the capital.
Example 2
The same £50,000 loan is made over a 25 year term.
- The interest rate is still ten per cent.
- The first year's payment is £5,000
- £500 repayment of capital
- Repayment £5,500 total
Whilst this certainly makes the mortgage payments more acceptable, the drawback is that if the borrower moves house again two or three years later they might find that they have repaid very little of the £50,000 that they originally borrowed.
On moving, they would probably take out a new 25-year loan and the whole process would start all over again. If they move house on a regular basis they might still be paying off a mortgage at an age when they wish to retire.
A repayment mortgage might be the best choice if you intend to stay in the same property for some time.
