Repayment mortgage is a more traditional mortgage for it is a very simple form of borrowing for residential home purchases. For its shear simplicity, it is also the oldest product on the market. A customer borrows money to buy their home… provided they fulfil the lending criteria.. money is advanced and the transaction is made.
The provided of the money actually secures his/her money for the most part against the property/home itself. The borrower for his/her part makes regular monthly payments over a pre-agreed time period. All being well, the borrower and the lender part company, hopefully amicably, at the end of the mortgage duration.
Mortgages used to run for 20 to 25 year period in the UK and elsewhere in Europe. However, since property prices have been rising upwards over the past 50 years, there are mortgage products available for 30 or so year periods. In Japan, it is not uncommon to find mortgage products on the market that run their course over a couple of generations; 50 to 100 year period.
Opting for a repayment mortgage appears to have advantages over other mortgages. One distinct advantage is that you are actually paying your capital as well as the interest right from day one. It is an advantage because you are not relying on some other mechanism to generate money to repay your mortgage. Consider the example of an endowment mortgage… where an investment is made into a fund.. which grows at the rate of the market… The rate of growth can vary between 5% to 20% depending on the market conditions. The difference in growth between 5% and 20% exposes the investor to some very serious risk. Using the repayment mortgage, you pre-empt any risk of shortfalls when you reach your agreed term time.
Senerio: How does the repayment mortgage actually work?
Total borrowing: $100,000
Term: 20 years
Initial interest rate: 5%
Each payment instalment contains an interest element and a capital repayment component. Therefore, first instalment @ 5% interest rate
= $416.67 + $300 (to repay the capital) = $716.67
12 months later, the monthly instalment will be =$401.67 + $ 300 = $701.67. The reason for reduction is interest element is as follows:-
1)The payment for the capital over 12 months period are $3,600.
2)This $3,600 (money paid) reduces the capital still outstanding to $96,400 from $100,000 the amount originally borrowed.
3)The reduction in interest payment to $401.67 from $416.67 per month is due to reduction in capital
The point being that the interest element will continue to reduce at a constant rate. In fact, towards the end of the mortgage term the bigger of the two elements namely the interest and the capital portion will be the capital element. The monthly outgoing will reduce in proportion to the reduction in the interest portion.
Finally, although the payment for the repayment mortgage started high. Admittedly, the initial payments are higher by comparison to say an interest only mortgage. Therefore, there are implications in cashflow terms and also standard of living for the borrower. This factor alone may appear to be a distinct disadvantage at the very start but the borrower is better off in the long run. Better off, because the monthly repayments reduce on a sliding scale to a much lower figure towards the end of the term. The other huge benefit for the borrower is that he/she does not have to make any lump sum payment at the end of the mortgage term. So, when you make your 240th payment the property is your to do as you please … it is totally unencumbered… free from any debt.. so no third party is holding any legal charge over it…
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