For most people, their mortgage represents their largest commitment both in terms of amount owed and the monthly payments associated with it. Ensuring that a mortgage remains affordable must be the first priority when deciding how much to borrow.
Mortgages broadly fall into two categories. The first is Capital & Interest Repayment. This method ensures that as well as the interest that accrues on the borrowed sum, that also a portion of the monthly payment goes towards repaying the capital so that the loan decreases over time. If you make your mortgage payments in full and on time the loan is guaranteed to finish over your specified term and there is no risk with this method that your mortgage will not be paid off.
The second method is Interest Only and as the name indicates, only the interest payment is made to the lender each month. No capital is paid off as part of the regular payments and the loan does not decrease over time. This system is obviously cheaper than the Capital & Interest Repayment method.
Historically, borrowers would have had to set up an investment policy (such as an ISA, Endowment or Pension policy) which would be designed to provide a cash sum sufficient to clear the mortgage at the end of the term. Many Lenders nowadays do not insist on such a policy being taken at outset and are happy to allow customers to borrow on an Interest Only basis on the understanding that the clients will repay the loan at a future point from whatever means. This is particularly useful for borrowers who may wish to pay off their mortgage with ad-hoc capital overpayments such as bonuses, commission payments, inheritances or the sale of other assets for example.
Calculating the cost of an interest only mortgage is simple because the term of the mortgage is irrelevant. Take the loan amount, multiply it by the percentage rate of the mortgage and divide by 12 to arrive at your monthly payment.
So for example, borrowing £150,000 at a rate of 5.75% would cost £718.75 per month (150,000 X 5.75% /12).
Calculating the cost of a Capital & Interest Repayment mortgage is however not possible without the use of a scientific calculator as not just the rate but also the term of the mortgage affects the final figure.
As a rule of thumb however, assuming a 25 year term and an interest rate of 5.75%, you can work on an approximate monthly payment of £6.30. So as an example, borrowing £150,000 would cost £945pm (£6.30 X 150). It may surprise you to learn that reducing the mortgage term by 5 years would only increase the cost per thousand to about £7.
Please visit our website where you will find an online calculator that will be able to provide you with figures on both types of mortgage. The calculator is set at 5.75% which represents a reasonably achievable mortgage rate for both home-movers and remortgage customers but you may want to increase this rate to see how fluctuations to the Bank Base Rate will affect your payments going forward.