Topic 20: Mortgage repayment methods

Question 1

What is Interest Only Mortgage?

Answer 1

Each monthly payment consists of interest; no capital is repaid. At the end of the term the borrower must pay off the capital outstanding, which will be the same as the initial mortgage. In most cases the borrower will arrange an investment product to build up the capital over the term to repay the mortgage. There is a significant risk that there may not be enough capital available to repay the mortgage.

Question 1

What is a Capital repayment mortgage?

Answer 1

Each monthly payment comprises some capital repayment and interest on the outstanding loan. The amount of interest charged reduces as the capital is repaid, and the amount of capital repaid each month increases. The borrower is guaranteed to repay the mortgage by the end of the term as long as the required payments are met.

Question 2

What is Annual rest?

Answer 2

Interest charged for the whole of the coming year is based on the capital outstanding at the start of the year. The capital element of any payment is not credited (ie deducted from the mortgage balance) until the end of the year. Out of the methods for calculating mortgage interest, this results in the highest interest charge overall and the slowest debt reduction.

Question 3

What is Monthly rest?

Answer 3

Interest charged for the coming month is based on the capital outstanding at the start of the month. The capital element of any payment is not credited until the end of the month. Out of the methods for calculating mortgage interest, this results in less interest overall and quicker debt reduction.

Question 4

What is Daily rest?

Answer 4

Interest is calculated on the balance outstanding at the end of each day, and capital payments are credited immediately. Works out the same as the monthly rest method if the borrower just makes required payments, but will result in less interest overall and quicker debt reduction for those who make additional one-off payments or higher than required monthly payments

Question 5

What is Second annual percentage rate of charge (APRC)?

Answer 5

Lenders are required to provide a second APRC figure if an MCD regulated mortgage is on a variable basis, with the interest rate used based on a previous higher rate of interest.

Question 6

What are the advantages of Capital Repayment mortgage?

Answer 6

• Debt reduction
• Guaranteed repayment
• No investment link

Question 7

What is the main disadvantage of capital repayment mortgage?

Answer 7

The main disadvantage of capital repayment is that there is no built‑in life cover. This must be arranged separately, although decreasing term assurance
cover is generally inexpensive and will pay off the mortgage if a borrower dies before the end of the term.

Question 8

How to work out the monthly interest payments for a Interest Only Mortgage?

Answer 8

The capital is multiplied by the interest rate and then divided by 12. For example, a £150,000 interest‑only mortgage with an interest rate of 5 per cent would be: £150,000 x 5% = £7,500 ÷ 12 = £625 per month

Question 9

Explain some acceptable repayment methods for interest only mortgages?

Answer 9

Acceptable repayment methods could include regular payments into a
savings or investment product, the allocation of regular bonus payments to pay down the capital or the sale of another property. Speculative strategies
such as relying on house price inflation, potential inheritance, windfalls or ad‑hoc investments are not considered to be acceptable approaches.

Question 10

WHAT IS A ‘PURE’ INTEREST‑ONLY MORTGAGE?

Answer 10

In a very limited number of situations it may be appropriate for the lender to arrange an interest‑only mortgage with no repayment vehicle. Known as ‘pure’ interest‑only, this applies where there is a degree of certainty that the mortgage can be
paid off without relying on speculative sources. An example is the eventual sale of the mortgaged property as the repayment method, but only where the value of the property should be sufficient to repay the mortgage. The lender cannot allow for house price inflation as part of the calculation, so the LTV of such a loan would be relatively low.

Question 11

What are the advantages of Interest only mortgages?

Answer 11

1. A wide variety of investment
   products can be used as repayment
   vehicles to build up the capital.
2. If the repayment vehicle performs
   better than expected, it may be possible to repay the mortgage early.

Question 12

What are the disadvantage of Interest only mortgage?

Answer 12

1. No capital is paid off during the term, which means the debt does not reduce
2. There is a significant risk that the
   chosen repayment vehicle will not
   produce sufficient capital to repay
   the whole mortgage at the end of the
   term, so interest‑only mortgages are
   not suitable for the risk averse
3. The total interest payable over
   the term is much higher than a repayment mortgage

Question 13

What is the Annual Percentage Rate of Charge (APRC)?

Answer 13

It enables a prospective borrower to compare the true cost of borrowing from different lenders. The APRC is regarded as a rate of charge because it takes into account some, but not all, of the costs involved in
setting up and administering a loan. In simple terms, the interest payable over
the term, and the additional costs, are totalled and calculated as an annual percentage rate on the mortgage amount. As a result, the APRC is usually higher
than the advertised (ie ‘flat’) rate, which represents the nominal interest rate charged on the mortgage amount alone.