Guide to mortgages

Use the quick links below to find more information diffrent mortgage terms:

Types Of Mortgage

Variable Rate
The basic mortgage rate, which most lenders offer, is a standard ‘variable’ rate (SVR). This generally moves up or down according to the Bank of England Base Rate changes. However, banks and building societies do not always pass on these changes to their customers, or delay doing so, which can make it worthwhile shopping around. Special rate deals revert to the variable rate at the end of the ‘discounted’ period. Some mortgage lenders guarantee their variable rate will remain within a certain margin of the Bank of England base rate at all times. Alongside the standard variable rate, lenders offer a variety of other rates and a range of special deals, which specific terms and conditions. These take the form of fixed, discounted, capped, LIBOR, base-rate tracker and flexible mortgages and deals that offer incentives like cashback.

Fixed Rate
This type of mortgage sets the interest rate you will pay for a given period of time – thereby guaranteeing that the amount you pay back each month will not change for that period. When the fixed time period expires, you will revert to the lender’s standard variable rate. The obvious advantages of fixed-rate mortgages are that if you are having to budget carefully over the first few years of your mortgage then you know how much you will be paying each month and you won’t be caught out by any surprise increase in the interest rate. Likewise, if interest rates rise above the fixed rate you are paying then you have the satisfaction of knowing you are saving money. The reverse is also true. If interest rates drop below the fixed rate you will lose out, but you will still be sure of how much has to come out of your bank account each month.

Fixed-rate mortgages usually last between one and five years, the best rates occurring in the one to three-year time frame. Some lenders offer fixed-rate mortgages lasting 10 years or more – in some cases, the full length of the mortgage term. How long a fixed rate you opt for will depend on your view of how interest rates are going to move over the next few years, as well as the comfort you may get from knowing that whatever changes do occur, your payments each month will not change for that period.
Fixed rates have proven very popular with people looking to protect themselves against interest rate movements, particularly as variable rates have been as high as 18 per cent in the past. However, recent years have seen interest rates continuing to fall and many borrowers have been turning to base rate tracker mortgage instead, to ensure they benefit from those rate decreases as they occur.

Capped Rate
A variation on the fixed-rate mortgage, capped-rate mortgages guarantee that your monthly payment will never go above a set figure (or ‘cap’) within the time period. Below that set figure, the rate will move up and down in the line with the lender’s variable rate. This means you can be certain of the maximum amount you will pay and may benefit from lower rates as interest rates fluctuate.

Discounted Rate
This type of mortgage gives a discount on the lender’s standard variable rate for a specified period. This means that whether the interest rate goes up or down, you will always be paying a reduced rate for as long as the discount lasts. If interest rates are falling these deals can be very good news. Likewise, when rates rise you will always be paying less than borrowers on the SVR.

With the Bank of England Base Rate falling and expected to drop even further during 2002, discounted deals are proving popular with borrowers looking for a special rate and prepared to take the risk that rates may rise in the future. This risk arises because unlike fixed and capped rates, discount rates lack the comfort of a defined payment ceiling.

Discount rates are worth considering if you think the rate will average out below the fixed and capped-rate products in the market. Be warned, through, discounted deals can have stringent redemption periods attached.

Base-Rate Tracker
These faithfully track, by a set percentage, the Bank of England Base Rate. Every time that base rate changes so will the payments on your mortgage. This is fine when rates are going down as they ensure you immediately benefit from any savings, whether or not your lender has decided to pass on the change by lowering its standard variable interest rate. However, if interest rates go up, then so will your payments and you could be paying above the odds if your lender decides not to pass on some or all of the rate increase to its other customers.
A further advantage of tracker mortgages is that many lenders are now adding flexible features to them, such as the facility to over and underpay each month.

Flexible
Flexible mortgages can offer borrowers greater control of their finances by calculating interest daily and allowing the option of overpayments. Paying just a few pounds extra each month you can pay back the capital of your loan faster, considerably reducing the mortgage term and saving you thousands in interest payments. Once you have been paying the mortgage for a while, most flexible loans allow you can make underpayments and take payment holidays but only to the limit of any overpayments already made.

Some lenders also offer a cheque book or reserve account facility allowing you to draw down on your overpayment or, if you have equity in the property, to borrow more (to a set percentage of the property’s value and depending on your income). While most flexible mortgages follow the lender’s SVR a growing number of flexible lenders are now offering fixed capped and discounted deals – although often only for a limited period of four to 12 months.

Current Account/Offset
Current account and offset mortgages are the big new thing in the mortgage world. They allow you to save money by ‘offsetting’ the interest you pay by taking account of your credit balances in other accounts, such as your savings or current account. Historically most lenders charge you a higher rate of interest on money that you borrow from them than the level of interest you will receive from having money in accounts with the same lender.

Unfair? A lot of people think so and this is where the new breed of Current Account/Offset mortgages have arisen from. With these lenders if you have for example £5,000 in a current account and a mortgage of £150,000 - then instead of being charged interest on £150,000 you are charged interest on £145,000. This means that the money in your current account has earned the same amount of interest as the level of interest that you pay on your mortgage. Another added benefit is that there is no tax due unlike a normal current or savings account where interest is taxed at 20/40% based on your tax rate.

CashBack
Under cashback schemes, on completion of your mortgage your lender gives you a cashback cheque which you are free to spend on whatever you want. The payment is a tax-free lump sum, normally either a set figure or a percentage of the total mortgage loan. Cashback offers can be ideal if all your saving have gone into providing a deposit for your new home, leaving you short of money to furnish it or pay for the move.

On the negative side, cashback deals inevitably tie you in to the lender’s standard variable rate for a number of years, with an early redemption penalty that can be three to six months interest or the repayment in full of the cashback amount.

Repayment Methods Explained

Repayment Mortgage
Repayment is the traditional means to pay back a mortgage – you make payments every month, part of which goes towards repaying the money you have borrowed – the capital – and part of which pays the interest on the loan (also known as capital and interest mortgages.) Installments remain the same each month, changing only as the Bank of England interest rate rises or falls and lenders interest rates follow suit. The advantage of a repayment mortgage is that provided you have kept up with the monthly payments you are guaranteed to have paid off the loan by the end of the mortgage term.
In the early years of a repayment mortgage, more of the installment goes on paying the interest than the capital. Over time, as more of the capital is paid off so the amount of interest reduces until the total loan has been paid back.

Interest-only Mortgages
With an interest-only mortgage you do not pay back any of the capital until the end if the mortgage term. You pay the lender interest on the loan each month. Repayment of the capital is usually covered by long term payment into an investment scheme, designed to have accumulated sufficient returns by the end of the term to pay off the loan – and even to have grown to give you a surplus lump-sum payment too. There are various types of investment schemes used to cover an interest-only loan. There are various types of investment schemes used to cover an interest-only loan. The most common has been as endowment policy but mortgages linked to pensions and ISAs are also available. It is also becoming more popular to downsize at the end of the mortgage term. This involves selling the family home and moving to a lower value 'smaller' property once the family has flown the nest. Flexible mortgages are sometimes arranged on a pure interest only basis as they allow you to make additional repayments at the times to suit you. Some people have even used regular bonus payments to make balloon payments off the mortgage balance.

Endowment Mortgages
With an endowment mortgage you pay interest on the loan to the lender and premiums into as investment plan. These plans are usually run by insurance companies and include life cover. They are designed to pay off the capital at the end of the mortgage term or if you die within that term.
However, much depends on the performance of the fund into which your monthly payments are invested. Many people who took out endowments during the 1980s when stock markets and percentage returns on investments were high, have found that the low returns of the 1990s and since have left them with a current shortfall and the possibility that the endowment will not meet the payment of the loan at the end of the mortgage term, let alone provide them with a welcome lump sum over and above that amount. As it is linked to an insurance policy which does not mature until the end of the mortgage term, an endowment requires a commitment for the full term of the mortgage if you want the benefit. The insurance policies can have a surrender value after they have been paid for a number of years but that value can often be less than you have paid in. How much an endowment will cost will depend on your age, health and the length of the mortgage.

ISA Mortgages
With an ISA (individual savings account) mortgage you pay the interest on the loan each month and invest in an ISA, the cashing in of which pays off the mortgage at the term-end. ISAs have the advantage of a number of tax benefits but there is a limit on how much can be invested into an ISA each year. ISAs can be invested in the stock market, life insurance policies and cash. As with endowment policies the ISA's ability to repay your mortgage, will be reliant on stock market performance if invested in a stocks and shares ISA.

Pension Mortgages
These are available to the self-employed and those contributing to a personal pension plan; but not as part of company pension schemes.
With pension mortgages the capital sum remains outstanding for the length of the loan, on which you pay interest. Payment of the loan is met at the end of the term from the pension plan into which you pay on a monthly basis.
The advantage of a pension mortgage is that you claim tax relief on any contributions made to the pension plan. The disadvantages are that you are paying for your own home loan until you retire, thereby setting your retirement age in advance. You are also using part of your pension to pay for your mortgage, which means your pension fund will have to perform very well or your contributions have been high. And only 25 per cent can be taken as a tax free lump sum (under current legislation) – the rest must be used to purchase an annuity.