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A mortgage is like any other kind of loan but with two major differences. It is paid back over a long period of time (normally 25 years) incurring a lot of interest (over that period of time you’ll probably end up paying almost double) and it is secured against your property. This means that if you default on the agreement the lender can repossess your house.
There are two basic types of mortgage:
With a repayment mortgage the monthly payment goes towards paying of your loan and the interest incurred by the lender. The advantage of this kind of mortgage is the fact that you know with every payment your loan is getting slightly smaller but the major disadvantage is that the lender tends to make you pay most of the interest first. Consequently for the first couple of years the outstanding amount will not come down very much.
An interest-only mortgage involves just paying off the interest added to the outstanding amount by the bank. This means that you are not actually reducing the amount of the loan at all so it is imperative to make some other investment arrangement to cover the amount when the loan becomes due at the end of the mortgage term. The fact that you’re only paying the interest amounts to a smaller monthly payment but this is negated by the necessity of putting money away in some sort of savings plan at the same time.
If you are on a standard variable rate (SVR) your interest rate moves up and down with the lender’s own mortgage interest rate. This is normally set some way above the Bank of England base rate and will fluctuate accordingly. This will be an expensive product when compared to other deals but you will normally be able to make extra payments, saving on interest charges and be able to leave the lender without a penalty charge. Unfortunately lenders have a tendency to delay passing on any Bank of England base rate cuts with this product.
If you have a tracker rate deal then your interest rate will be a set amount above the Bank of England base rate and it will track it accordingly. This product is great in times of low interest rates but you could really find yourself feeling the pinch if interest rates start to rise. Only go for this sort of loan is you are confident that you could stretch to the extra payments that interest rate hikes would bring.
A discounted interest rate would allow you to pay slightly less than the lender’s SVR for a fixed period of time. This is fine until the fixed period comes to an end and you go onto the lender’s SVR with a corresponding rise in payment size. Chances are that you will also be tied in for the discounted period with early redemption penalties.
With a fixed interest rate you will stay on the same interest rate for a fixed period (normally two years, although some loans stretch to ten). This interest rate will be lower than the lender’s SVR and you have the security of knowing that your payments will not go up, even if interest rates do. However, conversely, your payments will not go down with interest rate cuts and you will normally be subject to penalties if you change mortgage providers during this fixed period.
If you go for a capped interest rate deal you can be guaranteed that no matter what happens to interest rates, you will not pay over a certain level of interest; the capped level. So with this deal you can benefit from falls in interest rates and you know the absolute maximum that you will pay. Unfortunately, such an arrangement will only be for an introductory period and will revert to the lender’s SVR when over.
A collared interest rate is the opposite of a capped interest rate deal. It is usually used in conjunction with something more attractive such as tracker or a capped interest rate and means that the interest rate will not fall below a certain level; the collar.
Cashback mortgage deals are normally offered in conjunction with other interest rate deals. With this feature, the lender will pay you around 3-5% of the amount borrowed shortly after the mortgage is finalised. This is a good feature if you’re going to need money for furniture or other home improvements but in reality is normally just a gimmick to suck you into a not particularly competitive product.
Flexible mortgages give you the opportunity to be exactly that – flexible. Depending on the limitations of the product you may be allowed to make overpayments, underpayments and take payment holidays. Some loans will also allow you to borrow more money without further approval from the lender, providing the total loan does not go over the predetermined limit. These features could be particularly useful for someone with a variable income, a person who is self-employed for example, but if you don’t need these features then it may be possible to get a cheaper deal elsewhere. Note that a lot of mortgages have flexible features even if they don’t have the word “flexible” in their title.
An offset mortgage allows you to link your main current or main savings account (or both) to your mortgage. Normally these accounts will be also held with your mortgage lender and they then allow you to reduce the amount you owe on the mortgage by the balance on these accounts before interest is calculated. In summary, as your current account and savings balances go up, you pay less on the mortgage and as they go down, you pay more.
Current account mortgages are similar to offset mortgages in that they offset the balance of your mortgages with savings, but with this product, current account savings and mortgage are normally rolled into one account that acts like a giant overdraft. This sort of mortgage could be for you if you are a higher rate taxpayer or have substantial savings. A current account mortgage requires a lot of monetary discipline, so if you’re not good with finances, try something more traditional.
Money
Affordability is the major consideration when choosing a mortgage.
Typically most high street lenders will lend a single person between 3 and 3.5 times their pre-tax salary.
Other credit commitments, such as to a credit card or personal loan will generally not be taken into account.
Some lenders will also allow you to add a proportion of any regular bonuses you receive to this base figure.
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