In one form or another, borrowing plays some part in most people's lives, whether it is a mortgage to buy a home or credit cards as a convenient way to shop. Borrowing enables you to bring forward the time at which a financial target can be met and is worth considering if there is not enough time available to use the savings route or if the cost of borrowing is lower than the return you would get on saving.



Few people can afford to buy a home outright, and it would be totally impractical to save up the full cost of your home before you bought it; after all, you need somewhere to live in the meantime. Therefore, the usual practice is to take out a mortgage - a loan secured against the property you are buying. This practice has been encouraged by past governments through the giving of tax relief on the interest paid on a mortgage to buy your only or main home. However, this tax incentive was abolished from 6th April 2000 onwards (except for some mortgages linked to home income plans). Without any tax incentive, it makes sense to pay off your mortgage as soon as you can - in contrast to the position in earlier years. The removal of the incentive has had a dramatic impact on the types of mortgage which are suitable for most people. In particular, endowment mortgages - which were a popular choice in the past - should now have no place in the financial plan of most people choosing a mortgage for the first time. And, for many people, some form of flexible mortgage will often be a good choice.

There is a wide range of mortgages to choose from, though they fall into two main groups:

?Repayment mortgages, where you gradually pay off the amount you have borrowed over the term of the loan, together with interest

?Interest-only mortgages, where you pay only the interest on the loan during its term. Usually, you simultaneously make other arrangements for paying back the capital at the end of the term. In the past, the most common type of interest-only mortgage was the endowment mortgage.

If you were moving home today, which type of mortgage would you end up choosing? Back at their peak in 1988, more than 80 per cent of mortgage customers were choosing endowment mortgages. This is despite the fact that endowment mortgages had by then lost most of the advantages which made them a good buy back in the early 1980s. However, a consistent bad press and warnings from the financial regulators about the unsuitability of modern endowment mortgages for most people has finally taken effect. By 2003, only 3 per cent of new mortgages were endowment mortgages. Far and away the most popular type of mortgage taken out nowadays is the repayment mortgage.

Repayment mortgage

This is the most straightforward type of mortgage. Your monthly payments pay off both interest and capital, which, provided you keep up the payments, ensures that the whole loan is paid off by the end of the term.

A further advantage of repayment mortgages it that they are very flexible and can easily be adapted if you run into temporary difficulties in making the repayments. For example, the most common mortgage term is 25 years at the outset, but, if you ran into problems, your lender might agree to extend the term. This would have the effect of reducing the monthly payments, making them more manageable. Another option might be to add arrears to the amount of the loan outstanding and then adjust the monthly payments, so that the arrears as well as the original loan are repaid by the end of the term.

The way these repayment mortgages are structured means that your payments in the early years are almost completely devoted to paying interest, and very little goes towards reducing the outstanding loan. Critics point out that a move in the early years of the mortgage leaves you back to square one with no reduction in the amount you need to borrow.

A point also to bear in mind is that, unlike some other types of mortgage, there is not built-in life cover to pay off mortgages in the event of your death. If you have dependants, you will need to arrange separate life insurance, though this is easily done through a relatively cheap mortgage protection policy (a type of decreasing term insurance).

Two factors stand out to make repayment mortgages a good choice for many people. The first is their low risk. If on a one-to-ten scale (one being the lowest risk and ten being the highest) you feel most comfortable with a risk of, say, four or les, a repayment mortgage would be most suitable for you. The second factor is the flexibility. In the current climate of unstable work patterns and no tax incentives for mortgages, it makes sense to have the flexibility both to cope with possible hiccups in your earnings and to pay off you mortgage early if you can. You can build in even more flexibility by opting for a specially designed flexible mortgage.

Interest-only mortgages

These are the alternative to a repayment mortgage. You do not pay off the loan during the mortgage term. Instead, you pay just the interest and, in most cases, simultaneously pay into an investment to build up a lump sum which you will use to pay off the mortgage at the end of the term. The investment might be an endowment policy, ISAs (or, before April 1999, PEPs), a pension scheme, or indeed any other investment.

In effect, you are gambling that you can use the money you would otherwise have paid back to invest for a profit over and above the cost of borrowing that money. If your gamble pays off, you will either have an extra lump sum for your own use at the end of the mortgage term of you will have saved money during the mortgage term by paying out less each month than you would have paid for a repayment mortgage. If the gamble does not pay off, you either face a shortfall when you come to pay off your mortgage or you have to pay more over the mortgage term than you would have done with a repayment mortgage.

In the past, there were some good reasons why this gamble was likely to pay off. There are now some equally good reasons why the gamble may not work:

?Tax relief on your investment Up to 1984, if you took out an endowment mortgage, you got tax relief (called ?life insurance premium relief?) on the amount you paid into an endowment policy. This was abolished for new or altered policies from 1984. Now, only a pension mortgage offer you tax relief on the amount you pay each month in savings to repay the mortgage.

?Tax relief on the mortgage Up to April 1991, you got relief at your highest rate of tax on interest on up to ?30,000 of a loan to buy your only or main home. In April 2000, tax relief was abolished altogether. This makes borrowing much more expensive and reduces the likelihood that you will be able to invest the borrowed money at a profit.

So, although people who have had endowment mortgages in the past may tell you that in their experience they are a great deal, be aware that today's endowment mortgage is a very different product. Some interest-only mortgages - such as ISA mortgages - do still have tax benefits which might make them worth the gamble, but endowment mortgages do not have that advantage.