Types of mortgages
There are so many mortgages on the market and it pays to shop around for the best deal.
There are four main types of mortgage available:
Fixed rate: These fix the rate of interest you pay - usually for the first two to five years - although longer-term deals are available. This means you can budget accurately without having to worry about a sudden increase in your monthly payments.
However, once this time period expires your monthly payments return to your lender's standard variable rate (SVR), which is its own 'central' rate of interest that it can price and change as it pleases.
Variable rate: There are several kinds of variable rate mortgage deals, but the most common is known as a 'base rate tracker'. As it says on the tin, this tracks UK interest rates (known as the base rate) usually by a certain margin above. So when interest rates go up, so does your mortgage rate - and vice versa when interest rates go down. Again, this could last for a designated amount of years, or the life of the loan.
Capped rate: This literally 'caps' the rate you pay. So you will always know the maximum amount, but your payments will fall if either the base rate or the lender's SVR drops - depending on how the mortgage is priced.
Discounted rate: This is when you will receive an initial discount off the lender's SVR for an agreed period of time. Remember that, unlike the base rate, your lender can alter its SVR as and when it wants to.
Fees: On first glace, some deals may appear to good to be true, so it's important to look out for the fees charged by the lender. These include set-up fees and any early redemption penalties. Also look out for any special clauses.
Redemption penalties: Also known as early repayment charges, these are payable if you redeem the loan at any time during the agreed initial term. This is usually worked out as a percentage of the loan taken, which will probably run into thousands of pounds. So always ask about redemption payments when getting a mortgage and read all the small print. If you are just paying the lender's SVR, it's very unlikely you will be tied in so you won't have to pay a redemption penalty to leave.
Always ask about redemption payments when getting a mortgage and read all the small print.
There are three main ways of repaying your mortgage:
The most popular method, this is where you repay both the interest and the capital of your mortgage together over a set period of time (normally 25 years). For the first few years of the mortgage most of your monthly repayment is the interest on the loan and only a small amount is repaying any capital. After some time - depending on how much you pay each month - you repay more and more capital, and less interest. A repayment mortgage means you are guaranteed to pay off the mortgage at the end of the agreed term, assuming that you make all the payments on time.
Here the borrower only repays the interest on the loan each month, which means the capital debt (i.e. how much you borrowed) doesn't ever reduce. The borrower also takes out a saving scheme of some sort that builds up a lump sum to eventually pay back the debt. There are three main types of saving scheme:
- Endowment Policy: You pay cash into an endowment policy - obtained from an Insurance company or independent financial advisor (IFA) - throughout the mortgage term.
- ISA Mortgage: An Individual Savings Account that can be sorted out through banks, building societies, insurance companies or from and IFA. In this case, the savings money is paid into an ISA and that money is then invested on the borrower's behalf.
- Pension mortgage: Here the savings scheme is a personal pension and thus untaxed. Like the ISA, these can be obtained from banks, building societies and insurance companies, or from an IFA. The money paid into the pension will be invested on the borrower's behalf to eventually pay back the debt.
You can also have an interest-only mortgage without a savings plan, however this is rare and you need to prove you are expecting a lump sum of cash to repay the bulk debt, such as an inheritance. Bear in mind that when your savings vehicle is invested on the stock market there are no guarantees you will end up with the amount you need to pay off your capital at the end of the term.
As if all the above choices weren't enough, there are also newer kinds of mortgages that have recently been introduced, such as flexible, current account and offset. The Motley Fool covers these well. Many of them claim to save you lots of money over the lifetime of the loan.
If you are a first-time buyer and need some help sourcing a mortgage, it can be a good idea to enlist the help of an independent mortgage broker.
Read the comment policy
Use our free question and answer service and speak to an expert!