Choosing a mortgage can be really confusing. What exactly is a mortgage? What type of mortgage is the right one for you? How do I choose a provider?
There are so many different types of mortgages on the market, and so many lenders or mortgage providers, that it’s hard to know where to start. In this ‘all you need to know’ guide to mortgages we explain what they are and what the rules mean.
- What exactly is a mortgage?
- Choosing a mortgage?
- Repayment or interest-only?
- Which payment rate?
- Extras or a different style of mortgage?
- Which mortgage provider should I choose?
- Jasmine Says…
What EXACTLY is a mortgage?
A mortgage is a loan from a bank or lender that allows you to buy property. When you take out a mortgage you enter into an agreement with the lender to pay back the loan, plus interest. The interest is calculated as an annual percentage.
The payment rate is the percentage of interest you pay on your loan. This can and does change according to the economic climate (unless you fix your rate, which we explain why and how below).
The term is the length of the agreement you are making with the lender. For example, the term could be 10 years or 25 years.
Mortgages can involve ‘hidden’ costs – these are costs that you may not have considered when deciding what sort of mortgage is right for you. Click here for what to be aware of: Fees and Charges
There are a few extras and other options to be aware of which we explain in section 3. They can seem confusing but we’ve tried to explain them as clearly as we can so that you can make the best choice for you.
Lastly, you don’t have to do this alone. In our guide to mortgage providers you can find out all you need to know about how an expert can help you get the best mortgage for your needs.
CHOOSING A MORTGAGE
There are FOUR decisions you need to make when choosing what type of mortgage to get and how to get it.
- 1. Repayment or interest-only?
- 2. Which payment rate?
- 3. Extras or a different style of mortgage?
- 4. Which mortgage provider should I choose?
Once you’ve read our guide, you can head to our comparison tables powered by independent brokers London & Country for more detailed information.
1. Repayment or interest-only?
Repayment mortgages
These 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
These 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 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 too 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).
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.
You might also find mortgages offer a fixed rate term. This means after the term – usually two to five years – you won’t be on the fixed rate deal any more. Instead, you’ll be on a variable rate – which could be far more expensive. This is when you can shop around to find out if it’s cheaper to remortgage when you’re out of your fixed rate deal. Your exit fees could easily be far less than the amount you’ll save by switching mortgages, so it’s definitely worth looking into!
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 a lot 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
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.
make money from your house
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.
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 are 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.
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.
Cashback
Mortgage companies are 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%).
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. Some banks are now even lending for terms up to 40 years.
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.
4. wHICH MORTGAGE PROVIDER SHOULD I CHOOSE?
As you will now know, choosing a mortgage that is right for you is a huge decision and not one to be taken lightly. But you don’t have to do it alone. There are advisors and brokers out there who are experienced and knowledgeable about all the different elements you need to consider. These people will help you make the right choice.
We’ve got a whole page dedicated to how to choose the right mortgage provider for you:
Click here for more information on how to choose a mortgage provider.
Jasmine Says….
The best thing to do is to seek independent mortgage advice. A broker will be able to advise you on the best options for your personal circumstances – including looking at your future income and property plans.
Go to our mortgage comparison service and speak to London & Country about the best deal for you.
READ ON…
- All you need to know about ISAs
- All you need to know about Pensions
- All you need to know about Stocks and Shares
