Types of interest only mortgage
There are three main types of interest-only mortgage - in other words, three main types of investment vehicle which are used to pay off the loan. It's worth bearing in mind that none of these is guaranteed to pay off the loan, and you need to keep a careful eye on the value of the fund and be prepared to top it up as necessary.
The first type of vehicle is an endowment. The major benefit is that the endowment also includes life cover, which therefore doesn't have to be arranged separately. The major problem with endowments is the charging structure: if you have to "close" the endowment early its value may be substantially less than the amount you have paid in.
The second vehicle is an ISA (previously, PEPs). ISAs are explained in greater depth elsewhere, but the key benefit is that the money you pay in grows free of tax (other than tax credits on dividends). The major disadvantage is one of lost opportunity - you can only pay in a certain amount to ISAs each year, and if you are using this to pay off your mortgage you are losing the ability to make tax-free savings.
The final way to pay off an interest-only mortgage, and by far the least common, is using a pension. Most forms of pension fund let you take 25% of their value as a tax-free lump sum at retirement. The idea behind pension mortgages is that you are paying off the loan not only using a fund which grows free of tax (like an ISA), but you are also effectively getting tax relief on your mortgage contributions as well. The problem is a distinct lack of flexibility, and the fact that you can't pay off the mortgage before retirement.