Buying a home for you and your loved ones is a huge decision, and one that shouldn’t be taken lightly under any circumstances. Arranging a mortgage is a big commitment, regardless of your financial situation, so we’ve put together this guide to briefly explain the process behind mortgages and the different types of options available to you.
When do I need a mortgage?
You’ll need a mortgage if you need a loan to buy any kind of property. You can apply for a mortgage with a variety of providers, including building societies, banks and dedicated lenders and should always shop around for the best rates before committing to a plan.
What are my options?
There are two different payment methods for you to consider depending on the term (period) of your agreement.
A ‘repayment’ arrangement, also known as ‘capital and interest’, allows you to make regular payments every month until you’ve repaid the loan itself and the interest accrued. In the early years of the process, you will be mainly paying to strike off the interest rather than the capital.
- You will have paid the total debt amount at the end of the mortgage term
- You can choose to pay more towards your mortgage in the form of overpayments or lump sum payments, which will bring down the interest rates and capital amounts considerably
- You are not likely to experience negative equity as the balance of your mortgage will be reducing every month
- If your home hasn’t dropped in value since you took out the mortgage, your level of equity in the property should increase over time
- You may not have to organise life assurance when you take out this kind of plan
- If you plan to move again soon after taking out your first mortgage, you may find that you have to begin a new 20 or 25 year plan, as you pay for the accrued interest on your mortgage in the first few years rather than the bulk of the loan itself.
- If you do not have a sufficient life assurance policy and pass away before the loan has been entirely repaid, your next of kin may need to sell the property to clear the debt.
Interest only mortgages
Interest only mortgages allow you to just pay off the mortgage’s interest rather than its capital. These plans are a popular choice for first-time buyers worried about affording monthly mortgage instalments. Alongside the interest payments, you will also need to take out a separate ‘repayment vehicle’, which you will pay into frequently with a view to clearing the capital at the end of the mortgage term. This is typically in the form of a pension plan, endowment policy or tax free ISA.
- Interest only mortgages are known to be more tax efficient
- You can choose your own repayment vehicle
- If the rate of the investment grows above what is expected, you may either be able to clear your mortgage earlier or get a sum of money at the end of your term.
- If the repayment vehicle fails to achieve the amount you need to repay the capital, you will need to find the funds from another source or risk penalties. There is, after all, no guarantee that your alternative investment will provide the funds you need at the end of the repayment period.
- You’ll need to regularly monitor the progress of your repayment vehicle to ensure it’s on track to generate the sum of money you need.
- Repaying the capital much earlier could incur financial fees, though these will be outlined in the agreement when you take out the policy.
There are five different types of interest rates available on mortgages, the details of which are outlined below. Once you’ve chosen to take out either a repayment or interest only plan, you can then settle on an interest rate that best suits you.
Fixed Rate Mortgage
As the name suggests, a fixed rate mortgage demands that you pay your lender a set interest rate on a monthly basis for a specific time period. This fee will not be affected by any changes to interest rates in the broader market. Once the fixed rate period has passed, the rate itself will usually change to the lender’s own discretionary Standard Variable Rate. It’s important to bear in mind that many lenders will charge substantial fees should you choose to pay off your mortgage early (known as an ‘early repayment charge’, or ERC). The ERC can still remain applicable for some time after the fixed rate period has ended, so be sure to check with your provider as to the finer details of your agreement.
Capped Rate Mortgage
With a capped rate mortgage, your monthly payments may change subject to a variable interest rate. However, should the rate rise higher than anticipated, payments can effectively be capped so they will not exceed a certain amount. As with the fixed rate option, many lenders charge up-front and/or lock-in fees.
Variable Rate Mortgage
The variable rate mortgage demands that borrowers paying the adjustable Standard Variable Rate are subject to fluctuating payments, which may increase or decrease depending on a number of crucial market conditions.
Discounted Rate Mortgage
Many lenders will offer a discount on their Standard Variable Rate for a certain amount of time. The amount payable will fluctuate depending on the Standard Variable Rate, so fees can change for better or for worse. It’s essential to remember that, after the discount term has run its course, monthly payments are more than likely to increase, so borrowers must adjust their budget accordingly.
Tracker Rate Mortgage
The tracker rate mortgage offers variable rates that tie in directly with industry standard rates (the Bank of England base rate or London Interbank Offered Rate, for example). Naturally, the rate is subject to change and may be increased or reduced month by month.