Interest only mortgages have become more and more popular in the past few years probably as a result of the rise in house prices. With this type of loan, you pay off only the interest, so that your monthly repayments are lower than they would be with a capital repayment mortgage.

At the same time, you invest money in a separate savings scheme, and at the end of the term (usually 25 years), use the investment from the separate scheme to pay off the capital cost of your house.

This is a popular choice for people who would struggle to meet the mortgage repayments every month, or those who are confident that their investments will provide enough to cover the capital payment at the end of the term. The danger is that if your investment plan does not perform well, you may be left without enough to buy your house after the 25 years are up a time when most people are facing retirement.

There are three main ways to invest alongside an interest only mortgage, be aware that none of these are guaranteed to provide the capital at the end of the term.

Endowment Policies

Probably the most common investment for alongside an interest only mortgage. There are various different types of endowment policy, which involve your money being invested in the stock market. Some pay bonuses annually, and you can receive a one-off lump sum at the end of the term. Endowment policies have built-in life insurance.

PEPs and ISAs

Individual savings accounts (ISAs) replaced Personal Equity Plans (PEPs) a few years ago. ISAs are flexible investments with tax benefits investors are exempt from paying income and capital gains tax on their ISA. They can consist of cash, stocks, shares and insurance. At the time of writing there are limits on the amount you can invest, but these are set to be abolished soon

Pensions

A portion of your pension fund would be used to pay the capital of your mortgage at the end of the term which can be up to 40 years. This too is a tax efficient investment, winning you tax relief on the contributions. One pitfall of this type of investment is that you will have to use a significant part of your pension a lump sum to pay off the capital, which could leave you with a significantly reduced income when you retire.

Note that you may also be required to take out a separate life insurance policy along with your investments and mortgage.