Loans without moans

The repayment mortgage, sometimes called the capital and interest loan, is nearly always cheapest.

Every month your payment is split in two: one part is interest; the other pays off some of the loan. At the beginning of the mortgage, most of the money you pay is interest and only a tiny part repays the loan. Gradually, a greater proportion goes to pay off your mortgage, and the interest part shrinks.

This is also the only method which ensures your mortgage is paid off by the end of its term. You are not dependent on the stock mar ket performing well to pay off your debt.

If you are an existing borrower, you may already have a different type of mortgage. The alternative is an interest-only mortgage. As its name suggests, you simply pay off the interest each month, and the loan is left intact. Some people take out this type of loan intending to sell their home at or before the end of the mortgage term, using the resulting cash to repay their debt. Any money left over can be used to buy a less expensive home.

Although this is a cheap way of repaying the loan, it is very risky. The borrower depends on rising property prices to produce enough capital to pay off the existing loan and to buy a new home.

Most borrowers take out a savings scheme to run alongside their interest-only mortgage, contributing each month with the aim of building up a fund to eventually pay off the loan.

Unfortunately, millions who took out an endowment policy have been told that this may produce insufficient money to repay their mortgage. The investment returns on which their contributions were based have been revised to a lower level, after disappointing stock market performance.

If you are in this situation, you may be tempted to give up on the endowment and switch to a repayment mortgage. But Ray Boulger of broker Charcol warns that such people will be penalised by their insurance company, and lose some of the money they have contributed. 'If you are worried about there being a shortfall, you should continue with the payments and convert part of your mortgage (equivalent to the estimated gap) to repayment,' he advises.

Borrowers with Pep and Isa savings schemes may also be worried that their investments will not grow enough to repay their loans. Boulger says it is more difficult to get projections from investment firms, as their products are not designed specifically to run alongside mortgages and they are not geared to helping borrowers. However, a decent independent financial adviser should be able to produce a reasonably close result.

Investors facing a gap have choices. They can convert part of their loan to a repayment mortgage and continue with Isa contributions; stop contributing to the Isa and convert a larger part of their mortgage to repayment; or sell the Isa and use the cash to pay off part of the mortgage, converting the remainder to repayment. There are no penalties for stopping contributions to an Isa, and with the exception of a few M&G funds, none has penalties for selling up either.

A small number of borrowers with personal pensions choose pension mortgages, intending to repay their loans as they build up a retirement income. Investors can take 25 per cent of their pension fund as tax-free cash on retirement, and use the money to repay loans.

Only 25 per cent of the premiums are actually repaying the mortgage, so the monthly premiums are very large compared with other repayment schemes. To repay a £100,000 loan, you have to build up a £400,000 pension fund.

Pension mortgages are inflexible: you have to be aged 50 or more to withdraw your cash, so there's no chance of repaying the loan early. You may face problems if your employment status changes and you find yourself entitled to join a company pension scheme.

However, the tax advantages for a higher-rate tax payer are considerable, with 40 per cent relief on premiums. Boulger says: 'The arguments for and against are complex. Borrowers should definitely take advice.'