Types of mortgages

There are different types of mortgages available in Ireland and although they are not all widely available it is important to understand how they work in order to decide what might suit you best.

An annuity mortgage, also known as a repayment or capital and interest mortgage, is the most common type of mortgage.

Your lender works out how much you need to repay each month to clear the mortgage by the end of the term. Your monthly repayment is made up of two parts:

• An interest payment on the loan
• A capital repayment paid off the balance

At the start, most of your repayments will go towards paying the interest but as the amount you owe reduces, the interest portion goes down and more goes towards paying off the capital.

There is typically a variable or fixed rate to choose from or a combination of both known as a split rate.

Interest-only mortgages in Ireland are predominantly aimed at buy-to-let borrowers and those in the property investment area and not those looking to buy their own home.

With an interest-only mortgage, your monthly repayments only pay off the interest on your loan and do not repay any of the capital balance. The original amount you borrowed stays the same for the interest-only period.

With an interest-only mortgage the original loan amount is paid back by:

• Taking out a pension policy or endowment policy at the start of the mortgage to build up a fund to repay the original amount
• Selling the property and using the proceeds to pay off the loan

There is no guarantee that the value of the above policies or the proceeds of the property sale will be enough to pay off the original amount.

There are two main types of interest-only mortgages; a pension mortgage and an endowment mortgage.

With a pension mortgage, you pay off your mortgage when you cash in your personal pension policy but until then each month you pay:

• Interest on the original amount you borrowed
• Monthly payments into a personal pension investment policy. Tax relief on the pension contributions may be available

The pension policy is expected to grow enough in value to clear the mortgage when you retire and also provide you with a pension income but there is a risk that the policy might not be sufficient to pay off the balance of the mortgage. And if this happens you would need to repay the shortfall and this may leave you with a smaller retirement income.

With an endowment mortgage you pay interest off your mortgage and also pay into an investment policy, called an endowment policy, for the term of the mortgage. You then cash in the policy at the end of the mortgage term to repay the original amount borrowed.

The growth of the endowment policy depends on the performance of the investments it is linked to and is not guaranteed and may not be enough to pay off the mortgage.

If the endowment policy looks like it will not be enough to pay off the balance of the mortgage you could:

• Increase your contributions to the policy (again with no guarantee)
• Cash in the policy and use the proceeds to pay off some of the mortgage and take out an annuity mortgage to cover the balance
• Pay off a lump sum if you have the funds
• Extend the term, if possible to allow more time for the shortfall to be made up
• Take out a separate savings plan to cover any expected shortfall

A deferred start to your mortgage allows you to delay making repayments on your mortgage for a number of months, e.g. three or six 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 slightly before you begin to make repayments.

This can be a useful option if you need to furnish or decorate a new home but will increase the overall cost of the mortgage. Similarly your lender may allow you to take a payment break or pay your mortgage over 10 or 11 months rather than 12.