Cutting mortgage costs

Some lenders are reluctant to reveal the full range of options available, and may expect the borrower to come up with proposals to reduce the cost of the mortgage rather than making suggestions itself.

It is important, if possible, to pay the interest on the loan to avoid the total debt increasing and to prevent repossession. However, a lender may be willing to accept less than the full interest payments if the borrower is trying the sell the property. Even a nominal payment could be accepted for a short time, providing that the property is being actively marketed.

In some cases it will be better to maintain an endowment or life policy at the expense of interest payments, for example where the payment difficulties are expected to be short term or where the borrower is suffering from a life-threatening illness. Some endowment policies allow a break in payments as part of the agreement. Payments can be missed for a period of time (usually not more than 12 months) and the unpaid premiums then have to be repaid within a certain period of time. To find out whether this option is open to the borrower it will be necessary to check the policy and contact the insurance company.

Altering the method of repayment provides most scope for reducing a borrower's mortgage costs as it is possible to extend the repayment term to allow more time to repay the loan or select a more appropriate method of repayment.

Endowment policies can be cashed in or may be able to be sold for a cash value of more than the surrender value. This may be a useful way of paying off arrears if an acceptable alternative can be found to cover the mortgage. If the endowment policy has been 'assigned' to the lender (this means the lender holds the policy and has first claim to any value when it is surrendered), it cannot be surrendered or cashed in without the lender's permission. In practice, once payments have lapsed for three months the policy is likely to be terminated by the insurance company.

If selling or cashing in the policy is being considered, there are a number of options available to deal with the mortgage:

• The borrower could switch to a repayment mortgage that will usually be cheaper than the combined costs of an endowment. Repayment mortgages are more flexible in terms of methods of payment.

• The borrower could negotiate to switch to interest only. It will usually be necessary to arrange suitable insurance cover to pay off the debt in the case of death. This type of cover is called 'term assurance' and can be arranged very cheaply as it acquires no surrender value and has no minimum term. At some point in the future (ideally when the borrower is in a better financial position) the borrower will have to start repaying the capital sum borrowed with a new endowment policy or other scheme, for example a pension or PEP.

• The term of the endowment could be extended to reduce the size of the premiums, although this is less common than for repayment mortgages.

• The borrower could switch to a cheaper policy.

Alternatively, if the borrower is expected to be in a position to meet the full premiums in the future, the policy could be 'frozen', so that it is not paid up, or it could be terminated. This will ensure that the policy does not lapse and will give the borrower the opportunity to catch up with the missed payments at a later date.

With repayment mortgages several different arrangements could be negotiated, including:

• reducing payments by extending the repayment term

• reducing monthly payments by paying a lump sum

• payment holidays

• switching to interest-only payments.

When extending the repayment term or switching to interest only the savings will be greatest if the loan was originally scheduled to be repaid over a short period or where the mortgage has almost run its course and so the borrower is making larger capital payments. However, it is important to be aware that this course of action will substantially increase payments in the long term, in return for only small savings in the short term, for example, extending a loan for a further 10 years may reduce a monthly payment by only one to two percent but may increase the total payments by thousands of pounds.

Many borrowers with repayment mortgages opt for mortgage protection, a life assurance that pays off the loan if the borrower dies before the end of the term. Usually, the value of the policy decreases at the same rate as the loan is scheduled to be repaid. This keeps the premiums to a minimum. Mortgage protection is a relatively inexpensive form of cover and should be maintained if at all possible. A viable alternative would be short-life (two- to five-year) term assurance. Some borrowers insist that a life protection policy is taken out as a condition of the mortgage and so it would be necessary to gain agreement before changing this.

Payment protection is a form of insurance designed to meet all or part of the mortgage costs of a borrower who loses her/his job and/or becomes too ill to work. This insurance is relatively expensive. It is of limited use to borrowers who are self-employed or working on temporary or fixed term contracts; this group of people have very little prospect of making a successful claim against a payment protection policy because they are deemed not to have permanent employment.

Payment protection policies usually do not pay out for at least the first 60 days of unemployment or illness. However, because of the changes to the Income Support Regulations it is now more important that borrowers are adequately insured and maintain payments on these policies.

Although the property will normally be insured through the lender's own policy, borrowers will occasionally have made their own insurance arrangement with the lender's approval. Buildings insurance is essential and will generally cover the cost of rebuilding the property in the event of a fire, explosion or other hazard and will meet the cost of repairing damage caused in specific circumstances. Apart from a slight reduction in premiums achieved by changing to the company with the most competitive quote, there is little that a borrower can do to reduce this element of the mortgage.

When a borrower defaults on her/his mortgage, a component of her/his monthly payment may consist of buildings insurance premiums that will then be paid by the lender and added as arrears to the borrower's account, thus accruing additional interest.

Many lenders offer combined buildings and home contents insurance to borrowers but this option has tended to prove quite expensive compared to what is available on the open market. The borrower could be advised to look for home contents insurance elsewhere and ask her/his lender to alter the insurance to buildings insurance only.