Property's prime movers

James Hipwell examines the pros and cons of stand-alone mortgage repayment options

A MORTGAGE is the biggest financial commitment that most people ever make. One of the most important considerations is how you intend to repay the capital sum of your loan. Unless you opt for a repayment mortgage, which will give you the security of knowing that your mortgage will be repaid at the end of the agreed term, you will need to consider a separate savings plan. Here are the main types.

Endowments

The endowment mortgage consists of two elements. During the life of the mortgage, the borrower pays just the interest to the lender, clearing none of the loan, plus a monthly premium to an insurer to invest in an endowment policy. The endowment is designed to grow steadily in value, and the proceeds on maturity should be sufficient to pay off the loan in full and, hopefully, provide some extra cash that can be taken as a lump sum.

In the high inflation, high investment return environment of the Thatcher years the chance of a big surplus from an endowment policy once the mortgage had been repaid did not seem an unlikely prospect. Today, "poor value for money", "inflexibility" and "risk" are some of the charges often levelled at the endowment. Rather than providing a useful tax-free lump sum, the endowment may not be sufficient to pay off the loan.

If you have an existing endowment policy, there is widespread agreement among advisers that you should keep it, but what about first-time buyers - should they steer clear of the endowment method? "It depends on the individual," says John Wriglesworth, of the Bradford & Bingley Building Society. "If you are going to stay in the same house for the next 20 years or so then the repayment mortgage route will probably work out cheaper. But if you are going to move quite regularly, the endowment can work out to be more efficient."

PEPs

As a mortgage repayment method, Personal Equity Plans (PEPs) are making serious inroads. In terms of tax efficiency and flexibility, they beat endowment policies hands down.

Monthly contributions grow free of income and capital gains tax, investors can contribute anything up to pounds 500 a month, they can reduce payments if they suffer short-term financial problems, they can cash in their plans at any time and charges are lower than on rival mortgage repayment schemes such as endowment policies or pensions.

Unfortunately, this message has not been communicated to the mass market - only one in 100 borrowers repays a mortgage using a PEP, though the tide is now turning.

With an endowment mortgage, borrowers pay a monthly amount to their lender that covers interest. They also pay an endowment premium that provides insurance cover in the event of death before the mortgage is repaid and investment in a fund that should grow to repay the mortgage after a period of time, normally 25 years.

With a PEP mortgage, borrowers can separate all three mortgage components, enabling them to shop around for the best deals. They apply for an interest- only mortgage, take out life insurance and set up a PEP that aims to repay the mortgage capital. But with PEPs you have to remember that the value of your investment can go down as well as up. If the PEP performs badly, the loan may have to be extended beyond 25 years. A PEP mortgage should only be taken by someone who understands the workings of the plan, and who is comfortable with the benefits as well as the potential risks.

Pension-linked

mortgages

Pension mortgages are very tax-efficient but require higher regular savings.

In essence pension mortgages are similar to an endowment - an interest- only mortgage that is repaid in full at the end of an agreed term using proceeds from a separate pension plan.

With a pension mortgage the borrower pays off the loan using the lump sum payment available from the plan. Up to 25 per cent of the total pension fund accrued can be taken as a lump sum. But the plan's proceeds cannot, by law, be assigned to a third party (the lender) so a life assurance policy still needs to be taken out to run alongside and this is assigned to the lender. The life assurance policy will cover the cost of repaying the outstanding mortgage if the borrower dies before the end of the mortgage term.