Mortgages explained

There are literally thousands of mortgages out there. So which one do you choose? It's helpful to know just what's available before you start looking.

Our Mortgages explained guide explains the different types of mortgages to give you an idea of what meets your needs...

• The two main types of mortgage
• Interest repayment options
• Flexible Alternatives
• Remortgaging
• Lifetime Mortgages

The two main types of mortgage

Capital & Interest (Repayment) Mortgages

With a repayment mortgage you make a payment every month to the mortgage lender which includes both interest on the mortgage and a portion of the capital. In the early years, most of your payment is made up of interest, with the Capital balance reducing slowly, but over time, the amount of interest payable each month reduces, and so more of your payment goes towards repaying the actual debt.

The benefit of a repayment mortgage is that you can be certain sure your debt will be cleared by the end of the term, providing you maintain the repayments throughout.

Interest-only mortgages

With an interest only mortgage, your monthly payments only cover the interest due, making no payment towards the capital, and so, without a suitable means of repaying it, you will always owe the same amount, assuming Interest payments are kept up to date throughout the term.

Traditionally, clients taking this type of mortgage would also pay into an investment, such as an endowment, Stocks and Shares ISA, or Unit Trust/OEIC, with the expectation that over time, Capital will grow within it to eventually provide enough value to repay the mortgage.

Interest only mortgages can be useful if you are expecting a lump sum payment at the end of the mortgage term, such as an inheritance or Pension lump sum, and cannot afford to repay any of the Capital in the immediate term. They are often common when buying property to let out, and "Buy to Let" mortgages thus rely upon the growth in the property value to provide both enough Capital to repay the mortgage, and hopefully a profit, when eventually sold.

In recent years however, the growth in house prices has made it difficult for First Time Buyers to afford either a repayment mortgage on a suitable property, or indeed interest only with an investment running along side it. It is not uncommon for buyers wishing to enter the house ownership market with only an Interest Only mortgage, and either irregular saving towards it's eventual repayment, or, simply making overpayments to the mortgage to reduce Capital on an adhoc basis. There is some sense in this when compared to renting as an alternative, as at least you have an Equity stake in the property from day one, and hopefully, as salaries increase, inroads into the mortgage Capital can be made.

The benefit of an interest-only mortgage is that your monthly repayments to your lender can be significantly less than on a Capital & Interest basis, though the disadvantage is that you may not have enough funds to repay the capital at the end of the mortgage period, as investments can go down in value as well as up.

This type of mortgage suits a number of different borrower profiles, but there is an increased risk of non-repayment over the required term.

Advice should be sought in all instances to ensure the right type of mortgage arrangements are made.

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Interest repayment options

Mortgages, in terms of the rate type, usually fall into one of the following catagories.

Standard Variable Rate (SVR)

This is the lender's basic lending rate, which generally follows fluctuations in the Bank of England Base Rate and market conditions in general. Many borrowers move onto this rate once any initial special offer period has ended and never move again. It is always sensible to contact Your Mortgage Team if you find yourself on SVR, as significant monthly savings can be had from researching the market for a better deal. Lenders SVR's can vary considerably!

Good Points

• Usually there are no Early Repayment Charges.

Bad Points

• The rate is usually much higher than other special offers available.
• The unpredictability of interest rate movements makes it hard to plan your finances, and the costs of your mortgage may rise rapidly if interest rates go up.
• Lenders don't always pass on the full change in base rate, nor do they always do so in a timely manner. As profit making businesses, they may well pass on any rises very quickly, but could take a little longer to bring your rate down...!

Tracker Rates

Trackers work in the same way as SVRs. However, instead of the fluctuations being determined by the lender alone, the interest generally mirrors a rate set by an independent authority - usually the Bank of England Base Rate.

Good Points

• The interest rate is guaranteed to reflect movements in the market rates almost immediately.
• When the Bank of England Base Rate falls so do your payments.

Bad Points

• There can be heavy Early Repayment Charges in the earlier years.
• When the Bank of England Base Rate rises, your payments increase.

Discount Rates

A discount rate is like a variable rate in that it follows either the SVR or a tracker rate. However, it does so at a set discount and for a set period. Usually the shorter the discount period, the greater the discount. The 'price' of the discount rate is usually an Early Repayment Charge if you take your mortgage elsewhere during the term of the discount, and sometimes for an extended period after the discount comes to an end.

Good Points

• The initial discount will usually provide a cheaper rate and thus mortgage repayment than a standard tracker, and this can be useful in freeing up money for other expenses, such as new furniture or redecoration just when you need it most.

Bad Points

• The rate shifts to the lender's SVR at the end of the discount period
• The tie-in can apply beyond the initial discount period
• The Early Repayment Charge can be very expensive

Fixed Rates

With a fixed rate, the rate is fixed for a given period - normally two to five years, but there are occasionally very long term fixed rates, 10 years, or even for the lifetime of the mortgage. They can be worth considering when mortgage rates are perceived to be very low, with the potential for rises in the short to medium term.

Good Points

• Fixed rates are usually extremely competitive, particularly in a low rate environment
• You will know exactly what your mortgage will cost you

Bad Points

• There is a risk that rates could fall, leaving you on an uncompetitive rate
• Early Repayment Charges can still apply even after the fixed period has ended
• The initial fees, though often they can be added to the loan, can sometimes make the reduced rate less beneficial than other types of deal

Capped Rates

Rates on this product will not rise above a certain agreed level.

Good Points

• You're protected from interest rises, but free to benefit from falls

Bad Points

• The capped rate will be generally higher than a fixed rate for the same period

Cashback

A cashback mortgage offers you a lump sum cashback at the start of your mortgage, which you can use for expenses you may have. You'll normally receive 5%-6% of your mortgage.

Good Points

• You receive a lump sum to help you with expenses

Bad Points

• There can be steep Early Repayment Charges for a longer period than most other types of mortgage
• When assessing your requirements, our advisers will explain the alternatives and help to identify what would best suit you. We have some extremely useful comparison tools which calculate the total cost of mortgages over any given period, to build in the costs of fees and surveys, as well as thi monthly cost, to be sure the best value deals are recommended.

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Flexible Alternatives

More recently, lenders have extended the features of mortgages to provide flexibility to suit clients varied lifestyles. These may include -

• Offset Mortgages, where you can use savings accounts and current account balances to reduce the amount of interest youpay on your mortgage, thus reducing it's term. These can be useful for clients on higher salaries, where a good balance is maintained uduring the majority of the month. Careful arrangement of when Direct Debits and Standing Orders come out can make good use of this flexibility. Another version of this is tne all-in-one account, where your credit balances, salary and mortgage are all together. This may seem confusing to some clients, and can provide some merryment at the cashpoint seeing you are significantly in the red! Nevertheless, it has it's place in mortgage planning.
• Overpayments - Most mortgages these days, regardless of type of rate provde a degree of overpayment ability, usually up to 10% of the balance per year, with varying criteria on how this can be used, but many mortgages allow much higher levels of overpayment. If you know you will want to make a significant reduction in your mortgage balance, it is vital to find a deal which can accommodate your needs to avoid unneccessary charges.
• Repayment Holidays - Some lenders allow you to take a break from repayment your mortgage, for example when children come along (baby-break mortgages), but generally only if you have built up a "bank" of overpayments in the first place.
• Guarantor Mortgages - if you are struggling to meet the "income multipliers" for the mortgage you need, some lenders will allow a "guarantor" to be added, such as a parent, so that the lener feels more secure lending you what would normally be a much higher amount than your salary suggests.
• Let to Buy Mortgages - this can be very useful if you need to move into your new home before selling your old one, particularly if a chain exists which may fall down if you cannot move quickly enough. In this case, you switch to a Let to Buy mortgage, rent out your old home, and are free to move on. Many first time Landlords are created in this way!

Many mortgages have a number of flexible features built into them, and quality advice will ensure you get a mortgage that is best suited to your particular needs.

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Remortgaging

In simple terms, remortgaging involves switching your current mortgage to a new deal, arranged either with your current lender or a new lender. If you're a homeowner you may want to consider remortgaging for a number of reasons:

To Save Money

If you're paying your lender's Standard Variable Rate, you could find they may well offer a lower interest rate - especially as they would rather you stayed with them than shopped around. Alternatively, you can switch to another lender. By renegotiating your mortgage rate or adding flexible features, you could have lower monthly payments. On the other hand, if you maintain your monthly payment amount, you could repay your mortgage sooner.

To Raise Money

If you want to raise money to make property improvements or for other purchases such as a car, a wedding or a child's university costs, then it can often be cheaper to remortgage and increase the mortgage amount than to take out a separate loan.

This is because mortgage interest rates are typically lower than personal loan or credit card rates. You can increase the size of your mortgage if you have equity on your property, and your income is sufficient enough to meet the repayments.

It is not uncommon for clients wishing to get into the buy to let market to remortgage their home to release money for the deposit (typically 15% of the BTL's value), and fund the balance through a Buy to Let mortgage.

To Avoid Moving Home

It can be cheaper and more convenient to adapt or add an extension to your existing home, paid for by remortgaging, than to move home.

To Consolidate Your Debts

Other forms of debt are usually more expensive than remortgaging, so using the equity in your home to pay off your debts can be a sensible step to take. However you should consider the risks of moving unsecured debt into secured debt and the increased repayment period, and think carefulyy before securing other debts against your home.

To Meet An Endowment Shortfall

Instead of increasing your savings or investment contributions you may find that switching all or part of your borrowing to a repayment mortgage is a better way to meet any endowment shortfall.

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Lifetime Mortgages

These are a relatively new addition to UK Lender alternatives.

Where income or savings are short in retirement, you may be able to free up the Capital locked in the value of your home through a Lifetime Mortgage.

In general, up to 50% of the value can be released depending on your age, and unlike normal mortgages, no repayments are made to the loan. Instead the interest is rolled up, and repaid either on your eventual death, when you sell and downsize to a smaller home, or when you go into Sheltered Accomodation or Long Term care.

Good Points

• You can receive a lump sum to help you with expenditure you could not otherwise afford
• You can receive additional income to improve your standard of living
• It can help reduce Inheritance Tax
• You free up the value of your Home at a time when you most need it
• Most schemes provode a "no negative equity" guarantee, meaning that at worst, you may have no value left in your home by the time the mortgage is due to be repaid, but the amount of the debt will never exceed the value of your home.

Bad Points

• There can be steep Early Repayment Charges in some cases, depending on the terms of the mortgage and what repayment flexibility exists
• The interest can mount up to a considerable sum, especially if you are still relatively "young".
• Many schemes are inflexible, and once drawn, cannot be altered
• It canb reduce the value of your estate, and thus any inheritance your family may receive - it is always best to involve your family in discussions about this type of planning.
• Drawing income and lump sums from the value of your home may effect state benefits.

These are not an exhaustive list of the good and bad points of Lifestime Mortgages, and specialist advice is vital when assessing suitabilty of any such scheme.

Lastly on this topic, other schemes exists wher the value of your home, or part of it, it given up at outset to the lender in return for funds, and where you remain in your home until death, sometimes paying a rent to the lender. Again, these schemes should be discussed with a qualified mortgage adviser before any decisions made.

In summary, the mortgage market is vast, complex, and generally confusing! Always seek advice when looking for home finance of any kind, and remember that getting you in the home is only the first step - you should build into your budget the costs for appropriate and suitable lifestyle and property insurance - see our useful guide on this site, and talk to Your Mortgage Team today!

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