It’s hard enough saving up the deposit to put down on the house of your dreams, but then when you walk into your bank and they start using jargon such as off set, tracker and interest only, it all gets a little bit more bewildering. So how do you know which mortgage is best for you, which will allow you to pay off your mortgage in the best way and yet not affect your monthly outgoings too much? By looking at our simple guide to the different types of mortgages available, that’s how.
Basically there are two types of basic mortgage that you can get: Repayment (capital and interest) and Interest only (ISA, endowment or pension). Repayment mortgages are where your monthly repayments go to repaying the total capital amount borrowed together with accrued interest. On your mortgage statement, normally received annually, you will see that the outstanding balance decreases throughout the term. This means that at the end of the term, the total amount of the debt has been repaid. Interest only mortgages are used to pay off the interest only. At the same time, the borrower takes out an alternative ‘repayment method’ (way of paying off the mortgage) such as an ISA, pension plan or endowment policy. The most important fact to know about an interest only mortgage is that the monthly repayments do not repay any of the outstanding capital balance. It is important then that the repayment vehicle is designed to pay off the outstanding amount in full. Endowment – This is the most common type of interest only mortgage which also provides life assurance cover and a fixed payment for investment. The fixed payments are based on the amount of the loan together with the mortgage term and are designed so that, when they mature, the amount invested and earnings are sufficient to pay off the mortgage. ISA – The Individual Savings Account (ISA) is a tax free method of saving. This is a relatively new way of paying off a mortgage but is growing in popularity but due to the complexity of an ISA it is probably best only for the financially aware or borrowers taking advice from a suitably qualified financial adviser. Pension Plan – Life assurance cover is provided and monthly payments are made into a pension fund. When the benefits are eventually taken, the mortgage is repaid using tax-free cash from the remainder of the fund. The plan holder can then draw a pension from the balance of the fund. Again, this product, which tends to be used by the self employed, is best suited for those taking advice from a suitably qualified financial adviser.
Once you have decided on which type of mortgage, whether it be repayment or interest only, you prefer, you will then need to look at mortgage rates and there are five available: fixed rate, capped rate, discounted rate, variable rate and tracker rate.
With Fixed Rate Mortgages you can repay the lender each month at a fixed interest rate for a specified period of time, regardless of changes to interest rate in the market place. You’ll usually find that lenders offer fixed rates for a period of 2 to 5 years and at the end of the fixed rate (or ‘benefit’) period the rate will normally convert to the lenders Standard Variable Rate (SVR). A Capped Rate Mortgage is where the rate is capped at a certain level, and if that variable rate drops below the capped rate, the borrower will make payments based on the lower variable rate. However, should rates increase the payments will be ‘capped’ and will not rise over the capped rate. Discounted Rate Mortgages are where the lender offers a linked discount on the Standard Variable Rate (SVR) for a specific period of time. So the borrowers payments will increase if the SVR does, but at a discounted rate. Borrowers opting for the Variable Rate Mortgage will have their payments increase or decrease as the lender adjusts the rate in accordance with market conditions whilst Tracker Rate Mortgages are linked to what is happening at that time with a prevailing rate such as The Bank of England Base Rate or London Interbank Offered Rate (LIBOR). The payment rate will be a set percentage amount above the relevant base rate for a specified period of time.
There are many other benefits and features offered with mortgages, just to confuse you further. For instance, offset mortgages which basically works on the premise that you can use any savings you have and ‘offset’ them against your mortgage. Cashback mortgages in which the lender will offer a cash incentive to the borrower and lifestyle mortgages in which it is made very easy for the borrower to top up payments or take a payment holiday.