Interest Only Mortgage

With an interest only mortgage you make monthly repayments for an agreed period, but these will only cover the interest on your loan (endowment mortgages work in this way), not the capital. You're not actually reducing the loan itself.

This is why it's very important for you to arrange some other way of repaying the loan at the end of the term. You can achieve it by taking out a pension policy or an endowment policy that is expected to grow in value by enough to repay the original loan or selling the property and using the proceeds to pay off the loan.

If you choose Interest Only Mortgage you will need to check that your investment grows accordingly, so that at the end of the term you'll have enough money to pay off the loan. If it doesn't grow as planned, you will have a shortfall and you'll need to think about ways of making this up. The advantage of interest-only repayments is that your monthly payments will be lower. Anyway the most difficult part of this deal is that debt is not going to go away. Throughout the life of the mortgage, you'll need to keep your investment's return high enough to repay your loan at the end of the term. If you can't repay it at the end of the term you could lose your home.

Lenders usually offer Interest Only Mortgage to buyers in a strong financial position, for example those who buy the property as an investment (for rent).

There are two main interest-only mortgage options: a pension mortgage and an endowment mortgage.

Pension Mortgage

Pension Mortgage is designed for self-employed or employees who cannot participate in an employer pension scheme. Having a pension mortgage you pay off your mortgage when you cash in your personal pension policy. Until then, each month you pay interest on the original amount you borrowed and a sum into a personal pension investment policy.

The pension policy is expected to increase it's value by enough to pay off your mortgage when you retire and also provide a pension income. Check with your provider as you may be entitled to tax relief on your pension payments. However, there is a risk that the value of your pension policy might not be high enough to pay off the original loan or that the repayment may leave you with an income lower then you expected.

Endowment Mortgage

This type of mortgage works like a pension mortgage except that you clear your mortgage when you cash in a separate investment policy, called an endowment policy, at the end of the mortgage term.

However, your endowment policy growth is not guaranteed and may not be sufficient to pay off your mortgage. It depends on the investments it is connected to - share prices for instance.

If it looks like the endowment policy will not be large enough to pay off the balance of your mortgage, you should consider:

• increasing your contributions
• cash in your endowment policy to pay off a portion of your mortgage that you owe and take out a straightforward annuity mortgage to cover the balance
• paying off a lump sum if you only have enough money
• if your age permits, increasing the term of your mortgage to allow more time for the shortfall to be made up
• covering the shortfall at the end of the term with annuity mortgage or loan
• seek professional advice