Mortgages
The mortgage market can initially appear quite confusing, due to the many different mortgages. Comparisons should be made, and independent advice sought before choosing a mortgage.
Repayment Mortgages
There are two main types of mortgages: interest only mortgages and repayment mortgages. Repayment mortgages mean the consumer pays the original amount borrowed, as well as interest accumulated on the mortgage. This type of mortgage is guaranteed to be paid off at the end of the mortgage term, and for this reason it is the most popular type of mortgage in the UK.
Interest Only Mortgages
In an interest only mortgage only the interest of the mortgage is paid, so monthly costs will be cheaper. However, at the end of the mortgage term the homeowner will be expected to pay the original amount borrowed. This means the consumer pays into some other type of investment in the hope this will pay off the original amount borrowed at the end of the mortgage term. However there is always a risk attached to this. Investment types include Individual Saving Accounts (ISA), pension plans or endowment policies.
Both repayment and interest only mortgages have many different types of payment plans to choose from. Borrowers should consider carefully compare mortgages to find the mortgage best suited to their circumstances.
Fixed Rate Mortgages
Fixed rate mortgages mean that the interest rate of a mortgage is set for a specific period of time. The rate will not fluctuate in a fixed rate mortgage, regardless of changes in interest in the market. The period the interest is fixed is usually between 2-5 years.
Capped Rate Mortgages
Capped rate mortgages work in a similar fashion to fixed rate mortgages. The interest rate is fixed: however, if market interest rates drop below the fixed interest rate the borrower pays the lower interest rate. Any market interest rate increases above the capped rate do not need to be paid by the borrower: the interest rate is ‘capped’. Capped rate mortgages usually offer a better deal than a fixed rate mortgage.
Early Repayment Charge
There are some disadvantages to capped and fixed rate mortgages. Early repayment charges (ERC) usually apply to both mortgage types. This means that borrower is heavily charged if they pay off their mortgage earlier. The early repayment charge usually stays in place on the mortgage longer than the fixed or capped interest rate does.
Discounted Rate Mortgages
A discounted rate mortgage means the mortgage lenders offers a percentage discount on the standard interest rate for a period of time. The discount is linked to the current interest rate: so if the rate rises, the interest rate of the discounted rate mortgage will increase.
The advantage of a discounted rate mortgage is that if the interest rate decreases the borrower’s payment will decrease. In discounted mortgage, the interest rate paid is always lower than the market interest rate. However, if interest rates rise the borrower will have to pay this rate so this mortgage option is more risky than a capped or fixed rate mortgage. A discounted mortgage will only be cheaper than a fixed rate mortgage if interest rates fall, if they raise the price paid will be more.
Discounted, capped and fixed rate mortgages only offer discounts on the interest rate for a certain period of time. After this time, the mortgage repayments of the borrower can suddenly increase dramatically.
Tracker Mortgages
Tracker mortgages have their interest rates linked to base interest rates such as the Bank of England Base Rate. The rate the borrower pays is set a certain percentage above the relevant base rate. However, the rate the borrower pays is lower than the standard rate charged by the lender. The reason this is an advantage is that the lender’s standard interest rate often takes a long time to drop after the base rate interest rate drops. However, a tracker mortgage borrower will immediately see a drop in interest.
Flexible Mortgages
Flexible mortgages allow the borrower to make higher repayments (or ‘overpayments’) if they have extra money, and they are able to skip or reduce payments if necessary. Borrowers usually need to build a reserve of overpayments before they can lower or skip payments. These mortgages are usually more expensive than other options, but they do allow the borrower to have more control over their finances.
Offset Mortgages
Offset mortgages are a type of flexible mortgage which are linked to a savings or current account held with the lender. They are often also called Current Account Mortgages. An offset mortgage allows the borrower to use funds held in the savings/current account to offset the interest of the mortgage. If a borrower has a mortgage balance of £45,000 but has £1,000 in their savings account the customer will only be charged mortgage interest of £44,000. The interest is calculated on a daily basis. However, the current or savings account tied to the mortgage will not receive any interest.
Buy To Let Mortgages
A buy to let mortgage is suitable if the property purchased is used to rent out to tenants. These mortgages require a larger deposit than other mortgage types, and they also require rental income to cover a proportion of the monthly repayments. Buy to let mortgages can also be flexible mortgages. This allows the landlord to overpay or underpay depending whether the property is occupied.
The reason landlords need buy to let mortgages is that houses purchased for renting are considered a commercial interest. This would mean landlords should higher interest rates on their mortgage, as it is of higher risk to the mortgage lender. However, buy to let mortgages were introduced, and whilst they do have higher interest rates than standard mortgages they are much cheaper than in the past.
Self Certified Mortgages
Self certified mortgages are usually offered to borrowers who are self employed or have erratic earnings. A self certified mortgage is offered on the basis of likely future incomes. When choosing a mortgage, a borrower usually has to provide documentary evidence of their income. In a self certified mortgage, no proof of income is required. However, usually a higher interest rate is applied on this type of mortgage as there is more risk to the mortgage lender.