How good would it have been had there been no obligation to repay loan or mortgage? This is what most people think when required to make monthly repayments. But try as much as they can, they are never able to change situation. The borrower has to cut his monthly expenses to provide for repayment. The amount to be repaid includes principal amount of loan and interest calculated based on rate of interest prevailing in market. This is traditional method of repayment.
The loan amount is broken into a number of small parts for an easy repayment. The number of parts corresponds with term of repayment. Thus, if loan or mortgage is to be repaid in a period of five years, number of equal parts of loan will be 60. The repayments are to be made on a monthly or quarterly basis.
An improvement in method above was made to reduce burden of a borrower. The borrower is required to pay regular monthly installments as in earlier method. After a certain number of installments borrower can pay remaining balance of loan with a single balloon payment.
An alternative of traditional method of repayment is an interest only repayment. In this type of repayment, borrower is required to pay only interest. At end of term of repayment or any particular time period desired by borrower, balance on loan is repaid in full.
The monthly repayment in interest only method is far lesser than in former method. This is because monthly repayment in case of former includes both principal and interest. It is on this count that people prefer to repay through interest only method. However, this method of repayment increases cost of loan.
A repayment vehicle is created to repay loan or mortgage at end of term of repayment. The borrower is required to pay a monthly figure into repayment vehicle.
Pensions, endowment policies, and individual savings account are most important repayment vehicles. Pensions are widely used for repayment of loan or mortgage amount. An added advantage in case of pension policy is that employer pays half of amount of pensions. Thus effectively speaking, borrower spends only half amount in repayment. Being tax free, these repayment vehicles offer a cheap means of repayment.