MoneyMagpie

Mar 09

What type of mortgage should you get?

Aaargh! Choosing a mortgage – it’s a minefield of confusion. What type of mortgage is the right one for you? There are so many different types of mortgages on the market, and so many lenders, that it’s hard to know where to start.

Once you get down to it, though, you realise that there are three decisions you need to make when choosing what type of mortgage to get.

Then you can head to our comparison tables powered by independent brokers London & Country for more detailed information.

1. Repayment or interest-only?

  • Repayment mortgages are the most popular. Part of your monthly payment covers the interest on the loan and the rest eats away at the capital (the actual amount you’ve borrowed). It means that at the end of 25 years (or whatever the length of the loan) you will actually own your home outright.
  • Interest-only mortgages are slightly cheaper than repayment ones as your monthly payments only pay the interest on the loan. This means that at the end of the term (length of the loan) you will still owe the amount you originally borrowed. This means that most people set up a separate payment each month into an investment vehicle that will grow as the mortgage continues.

It’s very important to remember that if you plan to take out an interest-only mortgage, you really do need investments to back it up. Without them you are very vulnerable because – as we know all to well – property prices can drop, which could leave you in negative equity (where the value of your house is less than the value of your mortgage).

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2. Which payment rate?

Fixed Rate

With a fixed rate mortgage, your interest rate will stay the same for the term of your loan – no matter what. Regardless of what happens to the economy, the Bank of England base rate, or whether you have a repayment or interest-only mortgage, the amount you pay each month won’t change with a fixed rate.

Essentially this type of mortgage offers you stability and peace of mind. There is also the potential for you to save money if the base rate increases during the term of your loan.

On the other hand, you could end up spending more than you need to if the base rate goes down while you have the loan. The other problem is that fixed rate mortgages are likely to charge you for making early repayments or leaving before the end of the term.

This type of mortgage is good for…

First time buyers who are vulnerable to rising interest rates because they are on a tight budget. However those in unpredictable financial situations, for instance couples who are about to start a family, might also appreciate the stability a fixed rate mortgage offers. There’s alot to be said for always knowing how much you’re going to have to pay.

Tracker

This mortgage sets an interest rate that is usually just above the Bank of England’s base rate and goes up and down exactly as the base rate does. So if it’s set at, say, 0.75% above base rate and base is 5% then your mortgage will be 5.75%. The obvious plus (and minus) point with this is that while the base rate’s low you’ll have a cheap deal, but when it’s high your interest will be too.

This type of mortgage is good for…

Those who want cheaper repayments but can handle the flexibility of their repayments fluctuating (up and down!) The flexibility also gives the option to overpay without being penalised, which is good for those who can sometimes afford to throw some extra money at their mortgage to make it cheaper in the long run.

Find out more about tracker mortgages here

Offset

These are still a fairly new and relatively unknown concept in mortgages. Offset mortgages bundle up your current account, savings account and your mortgage into one product. This means that any credit in your current or savings accounts is ‘offset’ against your mortgage.

So although you pay the same amount into your mortgage each month, more of that money goes to paying off the capital of your debt (the actual debt itself) rather than being wasted on paying interest.

This is because the company only charges you interest on the amount of the mortgage that’s left after your savings are taken into account. So say you have a £100,000 mortgage but you have £20,000 altogether in your savings account and current account, you will only be charged interest on £80,000.

So, in theory at least, it’s cheaper and you get to pay the mortgage off quicker. It’s also very flexible so you can overpay when you like and borrow back money that you’ve paid off.

This type of mortgage is good for…

Those with substantial savings available to ‘offset’ – the more you have, the cheaper your mortgage will be. They can also be useful for those with fluctuating income streams like freelancers or the self-employed.

Capped

These mortgages have a variable interest rate but there’s a fixed upper limit which can give you the best of both worlds. The cap lasts for a fixed period (usually two or three years) within which, again, you are tied to the lender and charged high fees if you try to leave.

This type of mortgage is good for…

It is probably not your best option currently, but it is useful for those who think mortgage rates might fall but don’t want to pay more if they rise.

Variable or Standard Variable Rate (SVR)

This is the standard mortgage rate that lenders usually offer. It could go up or down, depending on what the base rate does and how much money the mortgage company feels like making.

This type of mortgage is good for…

These tend to be flexible which makes them good for those who might want to make early repayments or opt out early. The disadvantage is that they are generally a lot more expensive than other deals.

Discount

These offer a discount on the lender’s usual variable rate for a fixed period. They can be cheaper than the normal rate but they still could go up, even though at a lower rate, if the lender’s variable rate goes up in that time.

This type of mortgage is good for…

Someone who wants to get slightly cheaper repayments for a while and likes to have flexibility, but is happy to go through the switching process when the fixed period is over (because then the deal will just revert back to the more expensive SVR).

Flexible

More and more mortgages include some flexibility now – i.e you can overpay or underpay or even have payment holidays without being penalised.

This type of mortgage is good for…

These can be useful if you’re self-employed or expecting some life changes in the near future.

Bear in mind that the types of mortgage we’ve mentioned above are not mutually exclusive – you can for instance have a flexible tracker mortgage.

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3. Extras or a different style of mortgage?

Endowment mortgage

This is one way of paying off an interest-only mortgage. Very popular (with mortgage brokers) in the 1980s because it paid them a MASSIVE commission.

The idea is that you get an interest-only mortgage and then you invest in something else that, you hope, will grow faster than the mortgage interest rate. Then at the end of the 25 years you can pay off the mortgage and have a bit left over. Not only that but the endowment gives you life assurance to cover your debt should you die before the end of the term.

However, those 80s endowments did very badly because they overestimated how much the stock market would go up and, worse, they tended to have high charges paid to the brokers and the insurance companies that provided the policies. Generally a pretty bad product.

Use your pension or an ISA

These are also ways of paying off an interest-only mortgage. Either you can take out an ISA (Individual Savings Account) which will grow (you hope) enough to pay off the final mortgage debt.

Or, you can link part of your pension (up to 25% of the lump sum) into your mortgage so that it can be used to pay off the amount you borrowed at the end. You can only get at the money when you reach 50 but it’s quite a good investment because you get the amount you would have paid in tax added in.

Mind you, given that most people have pensions that are far too small, it’s probably best to avoid this type of mortgage.

Sub-prime:

If you have a dodgy credit history or you are self-employed and normal lenders won’t give you any money, you can still go to one of the mortgage companies who will lend – at a price – to people that no one else will touch.

The big disadvantage of these is that they tend to be much more expensive than normal mortgages. However, at least you can get the money and, possibly, switch to a cheaper deal a year or so down the line if you keep your nose clean and pay your mortgage on time every month.

Beware, though. Although there were lots of companies who used to give out these mortgages like sweets, there are hardly any now and it’s really difficult to get them. If you have bad credit and you want to remortgage, be prepared to pay a very high interest rate for the privilege!

Guaranteed:

Could mum and dad guarantee a larger-sized mortgage than you could afford on your own? Or could you do it for them? This mortgage is for people who can’t afford a large enough mortgage (on paper) because they don’t earn enough, or they are older than the mortgage company likes.

With this one, you pay the mortgage but a relative will guarantee it for you. If you can’t pay somewhere down the line, the mortgage company will come after your relative for the money.

Again, these mortgages are much less common now as banks cut down on the more unusual mortgage deals.

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Self-cert:

Also called ‘liar mortgages’ these are fast becoming an extinct species as banks get really twitchy about lending to anyone who doesn’t have a solid income and a huge deposit.

If you’re self-employed and your accountant saves you tax by making your income look small this can stop you getting a decent-sized mortgage. With self-certification (self-cert) mortgages you say what your real income is and the mortgage company lends on the basis of your say-so.

Most of the time they don’t ask for proof of your earnings, which is also helpful if it’s just a plain hassle to get your accounts together. Again, though, the rates for these loans tend to be higher than the norm because they are riskier.

Also, it’s far too tempting for some people to go for a massive mortgage, just because they can. Then they get into trouble when they can’t actually pay it each month. This is another reason why there are far, far fewer of these around than before.

Cashback:

Mortgage companies were so desperate to get your custom that they were offering all sorts of incentives including a percentage of your mortgage back as a cash lump sum (usually about 3-5%). Very few are doing it now but they could come back later.

This can be worthwhile but there’s always a downside, usually a higher interest rate overall and a tie-in deal that keeps you with the mortgage for a long time with heavy penalties for pulling out.

You really need to do the figures for these mortgages and work out if this deal really is cheaper in the long run or if there are too many hidden charges.

Sharia mortgages:

These are primarily for Islamic borrowers but anyone can take them out. In fact, they are becoming more popular as some non-Muslims believe they are more ethical than others.

The way it works is that the bank buys the property for you, then you buy it off the bank by leasing it from them over a period of time with a really big ‘rent’. It’s a bit like hire purchase for houses!

25-year fixed mortgages:

Where you fix your interest rate for the full 25 years. This is really only for people who really like to know exactly how much they will be paying for their mortgage every year and think that interest rates will go up over time.

The Government is keen on these (and they’ve been popular in the US for some years) as they make the property market less volatile. However, there are only a few on the British market and most have penalties if you pay them off early.

This can make them less worthwhile as we think you should definitely pay off your mortgage early if you can. If you find one that doesn’t have penalties, though, it could be worth considering.

 

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WHAT DO YOU THINK?

One thought on “What type of mortgage should you get?

  1. Has anyone thought about getting a 100% mortgage? Ward and Partners who are part of Arun estates are now offering 100% mortgages which they say helps first time buyers to get on the property ladder.

    Reply

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