Different types of mortgages available
The fixed rate mortgage is always a perennial favourite with borrowers, especially those people who are first time buyers. The fixed rate is, as the name suggests, a fixed rate of interest, so that however long the interest is fixed for that is the rate that you will be paying. This means that buyers know exactly what their repayments will be every month and even if the base rate that is set by the Bank of England or the lender goes up, it will not affect the amount of money repaid with a fixed rate mortgage.
Usually fixed rate mortgages last for anything between 2 and 5 years, although there are some mortgages available at a longer fixed term, but the interest rate may be higher.
The one down side to the fixed rate mortgage is that if the interest rates go down quite dramatically then you will pay over the standard rate, but at least the rate is fixed, so you know what the repayments will be.
Standard Variable Rate (SVR)
Strictly speaking the SVR is not actually a mortgage, rather it is the base rate upon which quite a few lenders actually calculate the interest rates that they will be charging. Usually the base rate is set by the Bank of England and then lenders follow suit. The SVR will go down and up during the lifetime of the mortgage.
Usually the SVR will be higher than any of the specific ‘deals’ that you may get offered for the mortgage. Historically almost any mortgage was an ‘SVR mortgage’ but now it is regarded as being a more costly option and SVRs are seen as expensive, with most borrowers being keen to ensure that they can secure another deal when the end of their fixed term mortgage comes, rather than reverting back to the SVR rate.
The term ‘remortgaging’ is often used to describe the process of coming to the end of one ‘deal’ and then taking out another, rather than going onto the SVR.
Discount mortgages or deals will offer a discount on the SVR that lenders have set and they are similar to fixed rate mortgages because they tend to run for anything from 2 to 5 years, with the discount being applied to the SVR, so the amount paid being variable.
Discount mortgages are good for anyone who wants to start off with a mortgage that does not cripple them financially in the early years and can really help trim back the costs of the mortgage in the beginning. However once the discount period is finished, it is normal for borrowers to look round for some other kind of deal.
Tracker mortgages following the base rate that is set by the Bank of England an they do this to a precise level. A tracker is generally offered at a level of “base rate plus x %“. So if the base rate is 5% and your tracker has a level of base rate plus .25%, then your rate of interest would be 5.25%. If the base rate increases to 6% say then your repayments follow suit, with the .25% on top. But if the rate falls then your repayments are reduced.
Tracker mortgages are quite unique because the lender has to pass on any rate changes to the borrower. With other mortgages offered at a variable rate, the changes can be discretionary, meaning that if the rate goes down the lender does not have to pass on the reduction.Some trackers are offered as a special deal where the % rate charged on top of the base rate is kept low for a period of 2 years or so.
Given that the interest rates have been low for a couple of years now, trackers are seen to be good value. However, if the base rate rises the tracker mortgages will become more expensive.
One thing to bear in mind is that the base rate is usually formulated by looking at the performance of the mortgage market and if you don’t take out a tracker until interest rates are on the rise, you will probably have left it too late to get a really good deal.
Capped mortgages start off with the borrower paying the lender’s standard SVR but if the SVR rises to the level at which the cap kicks in, then the repayments will be ‘capped’. Then when the SVR decreases, the repayments will also decrease.
Capped mortgages offer the advantage of having reduced repayments, whilst offering protection against any large increases.But you should bear in mind that the capped mortgage can be uncompetitive, since you will be on the SVR which will mean slightly higher payments than can be found with other mortgages.
Some mortgages, either fixed or trackers can come with a ‘drop cap’. This essentially allows you to ask your lender to set your interest rate at a certain point when the interest rates are on the rise.
Again, these often sound very good but in reality they will come with a premium attached which means that they will not be the most cost effective mortgage out there.
Offset mortgages enable you to join together our savings and your mortgage debt. It is standard practice to award savers less interest on their savings and make them pay more interest on their mortgage but if you combines the two then the savings are ’offset’ against the mortgage meaning that you don’t earn interest on your savings but you will pay the interest on the reduced debt (the outstanding mortgage and the savings combined as one total). Usually the lender will permit you to either pay less off the mortgage each month or will view the savings as an overpayment, which means you can pay off your mortgage earlier.
Basically a current account mortgage works in the exact same way as the offset mortgages but they take into account the funds that you may have in your current account. The daily balance is set against the mortgage meaning that you have funds that are taken into account offset against the mortgage and this can reduce the overall interest repayments.
Stepped rate mortgages are not generally offered, with only a few lenders providing them. The stepped rate mortgage offers an initial discount, which can be substantial and then gradually you step down the discounts until you end up paying the SVR that is set by the lender. These offer a good way of ensuring that if you are financially constrained at the start of your mortgage, you can ease into the full rate mortgage repayments.
Cash Back mortgages are something of a misnomer, because this is not a mortgage in itself. Rather you will be offered a mortgage at a fixed rate or tracker, but then you will be offered a cash payment when the mortgage commences, so it is a ‘teaser‘ to get you to take the mortgage. The cash back payment can be anything from a few hundred pounds, to a few thousand. Cash back payments of up to 10% of the mortgage were offered historically but the deals on offer are less generous now!
However, beware because there can be restrictions applied to these mortgages. For example, if you get a large cash back sum, then you may find that you are effectively handcuffed into the deal for a specific period of time and there is no way out. In addition you cannot use the money to repay the mortgage.
There are also drawbacks in terms of the interest rates offered, which are unlikely to be competitive, after all the lender needs to claw back the money they gave you as a cash back sum. So it is a case of weighing up if the cash back is indeed worth a potentially higher repayment rate.
Flexible mortgages are also not a mortgage per se, but merely reflect the fact that there is flexibility within the mortgage itself. Although the word flexible may vary between lenders, it usually allows borrowers to make either one off or regular capital repayments on their mortgage, or to make an overpayment each month. Flexibility will also allow borrowers to take a repayment holiday of up to 3 months on their mortgages. In some instances the flexibility will also be offered to you to borrow against the mortgage.
This is a very standard type of mortgage ‘product’. Here you repay some of the capital and a proportion of the interest. Usually what happens is that in the beginning your mortgage repayments are targeted at paying off the interest and it is only in the later years that you start to reduce the amount of capital on the mortgage. But at the end of the mortgage period you will have paid off the loan and the interest, so you will owe nothing.
Interest only mortgage
As the name suggests, this is a mortgage where each month you will pay off the interest that you owe only but when the mortgage is finished i.e. at the end of its term, you need to have the funds in place to repay all the capital that you borrowed.
Since you are responsible for meeting the cost of the capital, you will need to ensure that you have the funds in place. As a rule, borrowers tend to use one of he following investments schemes:
Endowment schemes throw your money and that of all the other investors into a giant pot and then invest it in the stock market.
However, this means that the investment may do well and meet all the cost of the mortgage, but on the other hand it could do badly, meaning that you will be left with no way of paying off the mortgage.
If you do opt for endowment mortgage but you are concerned that there could be a shortfall then you can choose to increase your payments, or to make some kind of payment off your mortgage either through regularly overpaying your mortgage or through making a one off payment as a lump sum.Another option is to begin another investment that runs in tandem, such as an ISA, to meet the shortfall.
One good thing to note about endowments is that they cover you for life insurance, meaning that you do not have to take out a separate policy.
Individual Savings Accounts (ISAs) come in the form of cash ISAs or equity/stocks and shares ISAs. As a rule only the equity or stock market ISAs will make enough money for you to pay off your mortgage. But either type do not have savings that are taxed and you don’t have to pay any capital gains tax if you withdraw your money.
However, it is worth considering that with ISAs the market can also do poorly and you could once again face a shortfall.
With this type of funding arrangement you effectively dip into your pension pot at the end of your mortgage. You can simply take money out of your pension (on a tax free basis) and then pay off the mortgage. However, the bad news is that you have to be 50 or older and you must leave some 75% of your pension pot untouched, so the maximum you can take out of this pot is 25%.
Sadly it is also important to note that similar to endowments and ISAs, the market can do poorly and you could still end up with a shortfall.