Types of mortgage
There are different types of mortgages and while they are not all widely available, it is good to decide what would suit you best. They include:
An annuity mortgage, also known as a repayment mortgage, is the most common type.
Your lender works out the amount you need to repay each month to clear your mortgage by the end of an agreed term. Your monthly repayment is made up of two parts:
- An interest payment on the loan
- A capital repayment (paid off the balance)
In the early years, most of your repayments will go toward paying off interest on your mortgage. But as your mortgage reduces, the interest part of the repayment goes down. So as time goes on, more of your monthly repayments go toward paying off the capital.
Interest only mortgages
There are two main types of interest only mortgage:
With an interest-only mortgage, your monthly repayment only pays the interest on your loan and does not repay any of the capital or mortgage balance. The original amount you borrowed stays the same for the term of the mortgage.
For example, James borrows €250,000 over 20 years at 3.1%. He pays €646 a month to cover the interest and at the end of the 20-year term, he has paid his lender €155,040. However, as his repayments have only covered the interest, he must pay €250,000 to his lender to clear his mortgage.
If you have an interest-only mortgage, you must repay the original loan amount by:
- Taking out a pension policy or an endowment policy at the start of the mortgage to build up a fund to repay the original mortgage. Be aware that the policy may not grow enough in value to repay your mortgage
- Selling the property and using the proceeds to pay off the loan
There is no guarantee that the value of your policy or the proceeds of your house sale will be enough to pay off your original mortgage at the end of the term, especially if house prices fall. So there is a risk that you could be left without enough money to pay off your mortgage, at a time in your life when you may be close to retirement.
Interest-only mortgages may not be available to all applicants. Lenders generally only offer them to people in a very good financial position. There is an increased risk of negative equity with an interest-only mortgage as you are not paying off the capital until the end of the term.
You can take out a pension mortgage if you have a personal pension plan or Personal Retirement Savings Account (PRSA), or if you are a proprietary director with an occupational pension scheme.
In general, lenders will lend you less if you take out a pension mortgage, than with a standard annuity mortgage.
With 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
- Monthly payments into a personal pension investment policy. You may be entitled to tax relief on your pension payments, so check with your provider
The pension policy is expected to grow enough in value to clear your mortgage when you retire and also give you a pension income. But there is a risk that the policy might not be sufficient to pay off the original loan. If this happens, you will need to repay the shortfall and the cost of that may leave you with a smaller-than-expected income when you retire.
With an endowment mortgage you pay interest on the original amount you borrowed and also pay into an investment policy, called an endowment policy, for the term of the mortgage. You then cash in the endowment policy at the end of the mortgage term to repay the original amount you borrowed.
Your endowment policy growth is not guaranteed and may not be enough to pay off the mortgage. The value of your policy will depend on the performance of the investments it is linked to, such as share prices.
Your endowment policy company should supply you with regular information regarding the performance of your endowment policy. However, if you are worried about a possible shortfall in your policy, you should contact either the person who sold you the policy or the endowment policy company and ask for:
- A summary of the current projected maturity value (surrender value) of your policy and
- A list of your options.
This will show you how much your policy is likely to be worth at the end of your mortgage term.
If the endowment policy looks as if it will not be large enough to pay off the balance of your mortgage, you could:
- Increase your contributions (but again with no guarantee)
- Cash in your endowment policy and use the proceeds to pay off a portion of the mortgage you owe and take out a straightforward annuity mortgage to cover the balance
- Pay off a lump sum now if you have the money
- Extend the term of the mortgage to allow more time for the shortfall to be made up if your age permits
- Take out a separate savings plan to cover any expected shortfall
- Continue your endowment policy and take out an annuity mortgage or loan to cover the shortfall at the end of the term
If you wish to cash-in your policy you can get the surrender value from your provider. Alternatively, you can sell your policy to an endowment trader who may be able to offer you a better price.
You might want a ‘deferred start’ or a ‘repayment holiday’ when you take out your mortgage.
Deferred start or late start mortgages allow you to delay the start of repayments on your mortgage for a number of months. Your lender will charge interest on the mortgage for these months and add it to the original loan. So your mortgage balance will rise before you begin to make repayments.
This can be a useful option if you are a first-time buyer and need extra money to furnish a new home or make improvements. However, it will slightly increase the overall cost of your mortgage as the unpaid interest gets added to the amount you borrow.
Some lenders may allow you to pay your mortgage over 10 or 11 months, rather than 12 months. This means that there would be a month or two during the year when you would not have to make a mortgage repayment, for example during December or during the summer.
If you arrange to pay your mortgage over 10 months, your monthly repayments will be higher to cover the cost of the two ‘skipped’ months.
These arrangements must be made in advance with your lender.
Very few lenders offer this type of mortgage product – it is also called a current account mortgage. This is a type of annuity mortgage that combines a variable interest rate mortgage with a current account.
Your salary is paid into your current account and you can deposit and withdraw money as normal. You pay your standard monthly repayment into your mortgage, and you can also pay in extra amounts or lump sums as you wish.
If your current account is in credit, you will be charged mortgage interest on the difference between the balance on your mortgage and the balance in your current account. In other words the money in your current account reduces the amount of interest due.
This allows you to pay off your mortgage quicker and save money because you can pay off the interest on your mortgage sooner than with other mortgages.
Remember to check the interest rate as it may be higher on this type of account. If you are combining your mortgage with your current account, check out the services available and any charges that may apply on your current account.