What type of mortgage should I choose?
A mortgage may just be a loan, but it’s probably going to be the biggest loan you’ll ever take out in your life, so it’s important to understand the options available and what will suit you and your finances best. What separates a mortgage from any other loan you may have is often the length of time you can take to repay it. Typically, a mortgage can be repaid anywhere between 25-35 years, so it’s a long-term commitment. The interest over this period may be low, but as it’s applied over such a long time it really can add up. It’s also important to be aware that a mortgage is secured on your home. In effect, this means that if you get into financial difficulty and are unable to make regular repayments, the lender has the right to repossess your home and sell it to recover the remainder of the money still owed. Further to that, if the reselling cost doesn’t cover the amount you originally borrowed, the lender will ask you to pay back the difference in instalments.
Therefore it's essential that you only borrow what you can afford to repay. Let’s break down the various options available. Repayment or interest only A repayment mortgage means that you are paying back both the interest on the loan and the loan itself every month. Repayment always makes sense if you are financially able. Interest only means just that – you are only paying back the interest on the loan and your monthly payment is not reducing the loan size at all. After 25 years of paying the interest back on a £200,000 loan, you would still owe £200,000 whereas, although repayment costs more per month, at the end of the term you will owe nothing. This can also be advantageous when it comes to remortgaging as you’ll have paid off more of the debt and can therefore get a mortgage with a lower loan-to-value (LTV) and consequently a lower interest rate. In recent years interest-only mortgages have become increasingly difficult to obtain due to the Financial Conduct Authority clamping down on them. Many people chose interest-only repayments in the belief that they would one day be able to pay them off with inheritance, a bonus, or house price rises, but this cannot be assured and has proven too big a risk to take for many lenders. Fixed or variable rate Essentially, if you choose a fixed rate mortgage, then no matter what happens with interest rates, your payments will stay the same for the length of the deal. You can choose to fix for two, three or even five years or longer, giving you financial security for that period of time and the ability to budget effectively knowing exactly what your mortgage payments will be. A fixed rate mortgage gives you a safety buffer against interest rate rises, but can mean that the rate is higher than a variable rate deal. For this reason, it’s important to work out how much you are happy to pay for that peace of mind. If you think you may need to move within the term, check that the lender allows you to move the mortgage with you (known as porting). It’s also worth checking whether if you were to buy a house of greater value and therefore borrow more, the lender will raise the cost of borrowing (some do).
As the name suggests, variable rate deals mean that your interest rate will go up and down, usually in line with changes to the UK economy. Interest rates tend to go up in times of growth and inflation, and down in a recession and this will be reflected in the rate you will pay. There are four different types of variable rate mortgages: Trackers With a tracker rate mortgage, your rate will literally “track” the bank of England base rate and go up and down in line with it. Therefore, if the base rate goes up by one percentage point, then so will your mortgage. And the same happens if it drops a point too. Standard variable rates (SVRs) Each lender will have an SVR which will very roughly follow the Bank of England base rate, it’s the rate a customer will go to once their fixed or tracker deal has ended so are rarely available to new customers. SVRs are often around two to five percentage points above the base rate but vary hugely among lenders. If the base rate rises or falls, lenders will move their SVRs but be aware it’s often the case that the lender won’t lower rates to as low as the base rate may drop to, but are very likely to increase the rates to the full base rate rise. This is solely to increase profit both ways. Discount rates These deals offer a discount off a standard variable rate deal and tend to last for two to three years only. The descriptions can often be quite confusing and are worth checking thoroughly before signing up. Some deals will tell you the rate with the discount applied and then the rate you will move to after the initial period ends. Others quote the initial rate, the amount of discount and then the rate you will move to after the discount is over. Some just quote the discount and SVR. In any case it’s essential to note the rate you will pay at the beginning of the term, and also the SVR.
Capped deals These deals offer a variable rate but one which is capped, so cannot go above a certain limit. The rate you pay still moves in line with the base rate or SVR but you have some security in the knowledge that your monthly payments won’t go above a set figure. Bear in mind though that the cap is generally set quite high to start with! Offset Mortgages An offset mortgage allows for your savings to reduce - or “offset”- your mortgage offering the ability to pay less interest. For example, if you have a mortgage of £200,000 and have savings of £20,000, then you only pay interest on the difference of £180,000. To take on an offset mortgage, your savings and mortgage must be held with the same lender. With interest rates on savings in general being so low currently, this may be a worthwhile option for those who can save while paying off their mortgage. The mortgage rate is likely to be higher than the interest rate you can earn on your savings so you can be much better off paying less interest on the mortgage. However, as you may have guessed, offset mortgages are often at a higher rate than standard mortgages. Because of this, generally speaking, unless you have a large amount of savings you can offset, or the offset rate is really cheap, it may not be beneficial to choose this option. To discuss any of these options in further depth don’t hesitate to contact us today. Our friendly advisors have helped hundreds of people to get on the property ladder and will be able to advise you on the best route to take to secure your new home!