Interest only mortgages

With this type of mortgage the monthly payment to the lender consists of only interest, with all capital borrowed being repaid at the end of the mortgage term.

These mortgages should be financed by an investment; however, this provides no guarantee of repaying the whole mortgage at expiry.

Using an ISA to repay the outstanding Capital

ISAs replaced PEPs in April 1999 and enjoy valuable tax concessions. Although contributions do not attract tax relief, capital growth within the ‘wrapper’ is virtually tax free and the proceeds are free from Capital Gains Tax. ISAs do not have a fixed term and are highly flexible, catering for cash deposits or investment in stocks and shares. Due to the favourable tax treatment the government has placed limits on annual contribution levels which for are as follows:

• Maxi Stocks and Shares ISA - £7,000
• Mini Stocks and Shares ISA - £4,000
• Mini Cash ISA - £3,000

Clearly, the borrower must have the inclination to maintain contributions during the course of the mortgage term and further investment may be required over and above the £7,000 limit in order to meet the outstanding mortgage amount.

Using a Pension Plan to repay the outstanding Capital

The Tax Free Cash payable under a Personal Pension Plan could be used to repay the outstanding capital under an interest only mortgage.

Individuals receive tax relief on annual pension contributions up to the greater of £3,600 or 100% of UK taxable earnings. The maximum annual allowance in respect of all pension arrangements is currently capped at £225,000 although this will increase each year (for example to £ by the year ). Payments in excess of this amount in any one year will be subject to a 40% tax charge.

Basic rate tax relief on contributions is reclaimed by the provider however higher rate tax payers claim the addition tax relief via annual self assessment Tax Returns.

Despite the tax concessions there are some drawbacks to pension mortgages:

• The accumulated pension fund must be at least four times the value of the loan as only 25% of the fund may be taken as Tax Free Cash.


• A recent change in legislation has meant that after 6 April 2010 the earliest age that benefits may be taken is 55. Therefore these arrangements are not well suited to younger borrowers. Someone aged 25 would need at least a 30 year mortgage term if using a pension plan to repay the loan.


• The scheme will require high monthly payments as both mortgage repayment and retirement planning are being catered for.

Using an Endowment Plan to repay the outstanding Capital

A unit linked Endowment Plan has a guaranteed death sum assured equal to that of the outstanding loan and the maturity value will be the total bid value of the units as at the maturity date. The monthly premium is calculated so that if the units grow at an assumed growth rate the maturity value will be sufficient to repay the outstanding loan in full. Therefore if investments outperform the assumed growth rate there will be a surplus upon maturity, however, if the return is less than that assumed, there will be a shortfall.

Life offices will review the performance of the Endowment Plan at specified intervals, generally after ten years and five years thereafter. If the growth rate is higher premiums will tend to be left unchanged however if there is a shortfall premiums will have to be increased or a top up policy effected.