Mortgage Advice - ISA Plan

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Individual Savings Account (ISA) Mortgage

An individual savings account ( ISA ) is paid into, to build up a capital lump sum, and the capital is used at the end of the mortgage term to pay the loan off. The savings plan runs alongside an interest only mortgage. This method is only recommended for the more financially sophisticated of borrowers, if you are not sure take advice from a qualified financial adviser.

At present, ISAs are the tax efficient way in which to invest, because all the income from the investment is tax-free. They were formerly known as PEPs, Personal Equity Plans up until 1999.

The dividends from shares with PEPs and ISAs are currently tax-free, but are soon due to become taxable from April 2004, but other income and gains will remain tax-free. ISA mortgages have three important advantages, even though they have a high level of risk:

1. ISA mortgage benefit from favourable tax treatment; unlike endowment mortgages.

2. The charges for an ISA mortgage are usually much lower than the charges for an endowment mortgage.

3. There are usually no penalties if you cash in an ISA before the end of the mortgage term.

Although ISA (and PEP) mortgages have the obvious tax advantage over endowment mortgages people have been slow to change to them. One of the reasons, maybe because the commission paid to mortgage advisers is lower on an ISA or PEP mortgage than on a usual Low-cost endowment mortgage. Or it maybe due to the fact that ISA investments have generally not shown good returns and mortgage borrowers do not wish to accept the level of investment risk that applies to this type of repayment vehicle.

Individual Savings Account (ISA) Mortgage

Until the introduction of bond-based PEPs and ISAs, this type of mortgage was at a higher risk option than a with profits endowment mortgage, this is because at any instant the stock markets may fall and the value of your ISA or PEP along with them.

In 1995 the PEP rules were extended to allow investment in bonds and preference shares issued by companies quoted in the Stock Exchange. In addition, the ISA rules also allow an even broader range of investment. It is now possible to use a medium-risk ISA investment to support a mortgage, but it is very improbable that these investments would produce enough return over the mortgage term, to make this type of mortgage advisable, due to the high cost of borrowing.

The ISA investment does not have any life cover included within the plan other than the return of the value of the investment on death. It is therefore usual to also consider some life insurance and critical illness insurance in addition to the ISA investment plan.

ISAs have the added advantage that they are generally very flexible with payments, and so should you run into temporary difficulties, you are able to limit or even delay payments into the ISA for a while. Nevertheless, self-discipline is required in order to guarantee that enough is paid into the ISA to build up the capital necessary, to repay the mortgage.

Since the elimination of tax relief on mortgage interest there is no gain in maintaining a mortgage for the long term, therefore it makes sense to pay off your mortgage as soon as possible, and if you can afford to then an ISA mortgage gives you the flexibility to pay your mortgage before the original term is up.

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