Midweek Money: A better way to buy a house

It pays to research the best mortgage deal, and choose your favourite way to pay.
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The Independent Culture
BUYING A house is the largest single purchase most of us ever make. As we are unlikely to have enough cash, we arrange loans. At first sight, the crucial decision to be made here is what rate to go for and whether it is fixed, discounted or capped.

In fact, the most important decision - which comes at the same time as finding a house and arranging the mortgage on it - is how to repay the loan.

Once upon a time, this was simple. We could opt for a conventional, standard repayment mortgage, paying a bit of capital and interest with each monthly payment. Or we could have an endowment mortgage, where just interest on the loan was paid each month, using the proceeds of a with-profits life assurance policy at maturity to pay off the advance.

Repayment mortgages remain the most popular, accounting for half of all home loans. "They suit most people, especially if they have a low-risk attitude and are in salaried occupations," says Siobhan Hotten, marketing manager of John Charcol.

Interest-only loans can be more flexible, as they can be transferred when you move house - though you may have to take out a top-up loan. They can also look as if they cost less, as you pay only the interest charge during the mortgage term. But you do have to repay the capital at the end.

Here, you are faced with a number of ways to repay the loan. Unless you know that you are going to come into a large windfall, you will usually save to pay off the capital through a savings scheme. All offer the prospect of creating a capital gain for yourself as well. The most popular ways to save are:

l Pep mortgages, where you make contributions into a personal equity plan. Then, whenever you have accumulated enough, you use the proceeds to repay the loan.

"Sales of Pep mortgages have fallen this year," says Colin Preston, director of DBS Mortgage Services. "This is because of the uncertainties of what will happen next April when Peps disappear and Individual Savings Accounts (ISAs) take over. Lenders have not yet produced any outlines of their products." However, it is safe to assume that most will simply swap ISAs for Peps when the time comes. As Siobhan Hotten says: "This type of mortgage suits someone who is aware of the risks involved with equity investment. When ISAs arrive, there's no reason why they cannot be used similarly."

l With profits endowment mortgages, where you pay premiums into a life policy using the proceeds to repay the loan. Nowadays, the low-cost versions of these plans assume the insurance company will continue to pay at least 80 per cent of the current bonus rate - that is, the profit made on the policy - with a forecast growth rate of 7.5 per cent a year.

Endowment mortgages, oversold in the Eighties, have been heavily criticised. They carry high charges and in recent years they have experienced falling bonus rates - or profits, although this has changed in the wake of high stock market returns. Overall, however, the likely returns may fail to keep pace with optimistic forecasts of future profits.

Insurers are more realistic about the growth rates they use to forecast the likely returns. Indeed, now that they will have to provide even lower "projections" - estimated total returns based on certain percentage rises in a fund's value - investors may find themselves paying slightly more to bridge any potential shortfall.

"Don't expect a cheaper mortgage with a massive lump sum left over at the end," warns Colin Preston. "But unlike with Peps, you don't need to constantly worry about whether share prices are going up and down. Also you get life assurance to which you can add critical illness, permanent health and unemployment insurance at much lower cost than if you tried to buy them separately."

Pension mortgages with the loan repaid from your pension fund. Under the current rules, at retirement you can take out up to a quarter of your accumulated fund in cash, using the rest to buy a pension.

If you use this money to repay your mortgage, you cannot use if for anything else, such as increasing your income. So this type of repayment is only really suitable for the highly paid who will accumulate lots of capital by the time they retire.

Flexible mortgages are now available from some lenders, including Alliance & Leicester, Bank of Scotland, Kleinwort Benson, Legal & General, Royal Bank of Scotland, Virgin and Woolwich. With these modern, lifestyle accounts, as long as you stay within the rules, your home loan is treated as just part of your overall borrowing. You can pay as little or as much as you can afford, as long as the mortgage is paid off in due course.

When looking at the options, decide what sort of risk you are prepared to take when it comes to your mortgage. The traditional repayment method carries little risk as long as you can afford the monthly payments. But if you want a more flexible method of paying a home loan, and maybe pay it off early or make gain for yourself at the end, then one of the interest only repayment methods may suit you better.

`The Independent' is offering a free 36-page Guide to Flexible Mortgages, with tips on all aspects of home loans, including how much you can borrow, how to repay the mortgage and a list of useful names and telephone numbers. For your guide, sponsored by First Active, call 0800550551 or fill in the coupon on page 13