In your best interest?

With interest rates at an all time low and looking to stay that way, now is a fine time for mortgage borrowers. For those with repayment mortgages, where every monthly payment chips away at both the capital owing and the interest on the loan, things should be ticking along nicely. For those with interest-only mortgages, though, the outlook is slightly different.

With interest-only mortgages, as the name suggests, each monthly repayment pays off some of the interest on the loan, but none of the capital. The idea is that, alongside your mortgage, you set up an investment vehicle into which you pay a regular sum with a view to building up a large enough investment to pay off the capital on your mortgage.

It used to be the case that mortgage lenders would make you take out a specific product, linked to your mortgage, to pay off your capital, or at least would ask for proof of another investment vehicle set up for that purpose. Now, however, many lenders leave it entirely up to the borrower to find a way to meet the capital payment at the end of the term, so that the onus is on the individual to choose an investment of their choice. In fact, they could simply pay off the interest and hope to win the lottery between now and the end of the mortgage term if that's the way they wanted to play it.

Those who do the sensible thing and invest for the term of their mortgage invariably choose equity-based investments, as these traditionally offer the best returns over the long term. So, for example, borrowers picked personal equity plans (Peps) when they were available, and now often opt for individual savings accounts (Isas) and other pooled investments, including pensions.

Not so popular nowadays, though, is the endowment policy. This is an equity-based investment with a contract that usually lasts the same length of time as the mortgage term, and which, on maturity, should amount to enough to pay off the capital of your loan. All too frequently though, in recent times, endowment policies have been failing policyholders and leaving them with massive shortfalls.

The policy providers themselves highlight these gaps. They are obliged to send out letters to policyholders detailing projected performances of their endowments, based on a range of different possible returns. With other investments, though, the onus is on the homeowner to check that things are going the right way.

Fluctuations leading to these shortfalls have occurred in large part because of the abysmal recent performance of the stock market: it doesn't take a huge leap of imagination to see that interest-only mortgage holders are also at risk of finding that other equity-based investments may not meet their requirements. As such, some borrowers may need to adopt a new strategy - and the sooner the better.

Of course, the stock market is a place to invest for the long term, so even if your investments have so far been disappointing, if you have 10 years or so left on your term, you could still make up the difference if and when the markets pick up. Indeed, explains David Bitner, head of mortgages at Bradford & Bingley's MarketPlace: "You may even benefit from pound cost averaging while unit prices are low. You are investing the same amount of money each month, but you are getting more units for your money, so when things pick up you will have more units going up in price with them."

Similarly, compared with endowments which often trigger penalties and the loss of the terminal bonus when cashed in early, Isas are pretty flexible. As Jonathan Smith, director of independent mortgage broker Mortgage-Adviser, says: "Isas are, in effect, annual contracts. So if, at the end of the year, you're not happy you can chop and change investments and you can choose to buy an Isa with another provider for the next year." You can select which sector you want to put your faith in, and which fund manager has been doing well, and then entrust your Isa allowance to that fund.

If, on the other hand, you are unwilling to start pouring even more of your money into the stock market for fear of watching it disappear down the drain, there are other options. "It is relatively easy to transfer from an interest-only to a repayment mortgage, and most lenders will let you do so, although you might have to pay a fee of, say, ?50," says David Hollingworth of London & Country mortgages.

And you don't have to transfer the lot, either. You can choose to move a percentage of your mortgage over so that you pay off a corresponding percentage of the capital, while continuing to use investments to pay for the smaller remaining percentage at the end of the mortgage term. And, says Mr Bitner: "If you are now paying less than you were on your mortgage as a result of lower interest rates, then you could put the extra amount you are saving into your investment vehicle." The extra investment could help counter poor stock market performance meaning you would further enhance your chances of meeting, or even exceeding, the amount of capital to pay off.

Because of the element of risk involved, interest-only mortgages don't suit everyone. With free-standing investments, in particular, you need enough confidence to place your trust in the stock market, and enough self-discipline to check your investments' progress regularly. After all, letting your investments get off track could mean you are faced with an enormous bill at the end of your mortgage term. And since that is likely to fall just when you're about to retire, it's probably the last thing you'll need.