Personal Finance: The model of a very modern mortgage

The traditional approach to home loans has had its day. By Iain Morse

NOT SO long both our working and financial lives seemed so predictable. We expected to work to 60 or 65, then hang our hats on a pension.

Mortgages were arranged with this in mind. Loans were structured on the premise that borrowers would enjoy regular, predictable and fairly secure income. Traditional "interest-only" mortgages, accompanied by with-profit endowments, had the great advantage to borrowers of evenly spreading the cost of house purchase.

The disadvantage of these loans, as many of us are now discovering, is their inflexibility. Many carry penalties for early redemption.

For example, Bradford & Bingley's four-year loan, which is capped at 5.9 per cent, has a penalty of 4 per cent of the amount that is outstanding on redemption during the capped period.

Elsewhere, Northern Rock offers a loan discounted by 2.5 per cent to just 4.45 per cent. The snag is a sliding scale of redemption penalties ranging between 5 and 3 per cent of any amount repaid within the first six years.

Meanwhile, our working lives have altered. We can now expect to change employer, employment status, and career several times before what may only be partial retirement.

Bonuses, lump sums, redundancy packages - these days we get plenty of opportunity to reduce or pay off our mortgages early. There are compelling financial arguments for doing this if it is possible.

For example: if you have a pounds 100,000 repayment loan running over 25 years, at a current variable rate of 7.49 per cent. The total interest to be paid on this loan would be approximately pounds 405,580.

But if you have a flexible mortgage , and find you can repay capital of pounds 10,000 after just one year, you will save pounds 40,558 in interest payments, and lop 5 years and 7 months off the term of the mortgage.

John and Penny Dablin illustrate just how a flexible mortgage can meet our changing circumstances. John, aged 52, is not too far away from retirement as a software engineer. Penny, a part time personal assistant, has a variable income stream.

Yet the couple have a 18-year mortgage, way beyond the period when they would ideally like it to be paid off .

The solution lay in opting for a flexible mortgage. While the notional target date to pay off the loan on their four-bedroom semi in Aylesbury remains 18 years, in practice they aim to have it repaid well before then.

"We currently pay about pounds 550 a month," says Penny," which is about pounds 150 more than we need to pay were the loan to run over its original 18 year term."

The couple used to have a traditional mortgage with a large former building society until they read about the option of having interest calculated on their loans daily rather than annually. Because over-payments can be take out again if needed, they transferred about pounds 10,000 from another high interest cheque account into the mortgage one.

"We now use our mortgage account as the high interest account we had before. That means that we are effectively earning a higher rate of interest on our money," Penny adds.

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 at the end. For your copy of the guide, sponsored by First Active, call 0800 550551.