Interest-only
or capital repayment method?
You should also give careful thought as to whether you are going for an interest-only mortgage or capital repayment mortgage. The capital repayment mortgage was fully described in Part I, and you will doubtless recall the various anomalies due primarily to how many rests there are per annum. However, we can leave that aside for the moment, as in the final analysis of our short list of products, we will include a calculation of the IRR anyway - the single figure which can be used to compare any mortgage schedule for the likely best buy.
An interest-only loan does not require any capital repayment to be made to the lender until the end of the mortgage or on earlier sale of the property. The capital is found from either selling the house itself, or from a separate investment scheme, such as an ISA or an endowment policy. It is not essential to have a savings scheme to start with. Most people move every six years or so, and they repay their mortgage out of the house sale proceeds, hopefully providing a sizable deposit for the next home. Usually a higher mortgage is negotiated on each move to match ones increased capacity to borrow. There is obviously a requirement to repay the loan eventually, probably on retirement, but it is difficult to know what you might eventually owe at that time.
Interest represents a very significant amount of money, particularly on the huge loans required for house purchase. So why not repay the loan as early as possible by using the shortest capital repayment mortgage you can afford?
There is only one reason. If, instead of repaying capital to the lender early, you can invest it first and achieve a higher percentage return on the investment than it costs to borrow the capital, it is clearly worth doing, since you are making money out of – well, thin air. This is the essence of gearing but it requires careful study to understand it properly.