Mortgages

With literally hundreds of lenders and thousands of mortgage products available, it is impossible to describe all of the various types of mortgage offered. This section does however provide you with information on the main types of mortgage and features that are available.

What is a mortgage?

A mortgage is an arrangement where an asset, typically property, is used as security for a loan. The purpose of a mortgage is to provide sufficient funds for a person or organisation to purchase a property that otherwise would be unaffordable. Types of borrowing can broadly be split in to three categories:

Residential property - property used and occupied by the owner and his or her family
Buy-to-let - property that is rented out to a tenant or tenants
Commercial - property used for commercial purposes, e.g. a factory or shop

What repayment methods are available?

Although there are many different mortgage products available, there are only two repayment methods available:

Capital Repayment

With a Capital Repayment mortgage, each monthly payment consists of an element of capital and interest. If the borrower makes all of the required mortgage payments, the loan is guaranteed to be repaid at the end of the mortgage term. At the beginning of the mortgage, the monthly payment consists mainly of interest. Gradually as the capital reduces, the interest paid each month decreases and more capital is paid off. The Capital Repayment method provides a low risk way of repaying a mortgage. A Capital Repayment mortgage is suitable for people who wish to guarantee the repayment of their mortgage.

Interest Only

With an Interest Only mortgage, each monthly payment consists solely of interest. As no capital payments are made the monthly payments are lower than with a Capital Repayment mortgage, however the debt does not reduce over time and the full amount borrowed will still be outstanding at the end of the mortgage. The repayment of an Interest Only loan is self-managed by the borrower, who would usually arrange an investment vehicle to run alongside the mortgage to build up the capital needed to repay the loan at the end of the term. A typical investment vehicle would be an Endowment, ISA's or Stakeholder / Personal Pension. In most cases, no guarantee is given that the investment will be sufficient to repay the debt in full. Unlike the Capital Repayment mortgage, the Interest Only mortgage is not seen as low risk. It is most suitable for people who do not wish to repay the mortgage until the end of the term.

What are the main types of mortgage?

Mortgages are classified principally by how the interest is charged. There are some additional features which are discussed at the end of this section.

Standard Variable Rate (SVR)

The Standard Variable Rate mortgage does exactly what the name suggests. The interest rate charged varies in line with the current market and interest rates. Each lender will decide what rate to offer, when to increase or decrease the rate and by how much. Generally there are no fees to set up this type of mortgage and the borrower will not incur a penalty for repaying the loan early, for example if they wish to switch to another lender. For this reason the rate offered by the lender on this type of mortgage is the highest rate you are ever likely to pay. This product may be suitable for a person who wants a straight forward mortgage, with no tie in. However, borrowers should be aware that it provides no protection against steep interest rate increases.

Discounted Rate

The Discounted Rate product offers a discount off the lenders Standard Variable Rate for a specified period of time. The main advantage of this product is that for a given period, the borrower will have the assurance that he or she will be paying less than the Standard Variable Rate. A variation of the Discounted Rate, which is offered by some lenders, is the stepped discount rate. The discount offered typically reduces over time, for example a discount of 1.5% in the first year, 1% in the second year and 0.5% in the third year. This type pf product can be helpful to borrowers who are looking to keep the costs low early on or are likely to have yearly salary increases in line with the discount changes, for example Accountants and Solicitors. When setting up this type of mortgage, the borrower usually pays an arrangement fee. This fee is either paid at the time of application or can, in many cases, be added to the loan. If the borrower wishes to repay the mortgage within the agreed discount rate term they will usually be subject to a financial penalty, commonly referred to as an 'Early Repayment Charge' (ERC). The main disadvantage of this product is that as with the Standard Variable Rate there is no protection for the borrower against steep interest rate increases.

Capped Rate

Although the Capped Rate mortgage is also variable and is based on the lenders Standard Variable Rate, the borrower has the certainty for a specified period of time that the rate will not exceed a predefined amount. Some products also include a collar rate, which is a predefined minimum rate that the borrower will pay. Borrowers taking out this mortgage will usually be expected to pay an arrangement fee and will be subject to an Early Repayment Penalty if they redeem the mortgage within an agreed period.

Base Rate Tracker (BRT)

The Base Rate Tracker is also a variable mortgage, however unlike the Standard Variable, Discounted and Capped Rate products the rate charged follows the Bank of England base rate. The rate charged is a fixed percentage either above or below the Bank of England Base rate and is either applicable for the whole mortgage term or for a specific period. The main advantage of this product is that the borrower has the guarantee that the interest rate will be reduced immediately following Bank of England rate decrease. As long as the borrower is aware of when the Bank of England rate changes, he or she will know exactly what rate change will be applied to the mortgage. Also, the rate charged is likely to be significantly lower than the lenders standard variable rate.

The borrower usually pays and arrangement fee for this type of mortgage and may be subject to an Early Repayment Charge if they redeem the mortgage within a predefined period. As with the Standard Variable, Discounted and Capped Rate products, the borrower receives no protection against steep interest rate increases.

Fixed rate

With a Fixed Rate mortgage the lender offers a mortgage at a set interest rate for a specific period of time, for example two years. The lender guarantees the borrowers payments for that period of time. The main benefit to the borrower of this product is that it can greatly assist with budgeting. An arrangement fee is usually payable and if the borrower wishes to repay the mortgage within the agreed fixed rate term they will usually be subject to an Early Repayment Charge. The main disadvantage of this product is that the borrower will be unable to take advantage of any fall in interest rates.

Flexible

Many lenders are now offering Flexible mortgages. To be classified as a flexible mortgage, the product must incorporate the following three features:

Interest calculated on a daily basis
The facility to make over payments without penalty
The facility to take a payment holiday

Offset

The Offset mortgage is similar to the Flexible mortgage in that it incorporates the flexible features. The main difference is that the borrower's mortgage is amalgamated with any savings they have which are then offset against the mortgage.

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Adverse Credit - The overall cost for comparison is 9.1% APR. The actual rate will depend on your circumstances. Ask for a personalised illustration.

Self Cert - The overall cost for comparison is 9.2% APR. The actual rate will depend on your circumstances. Ask for a personalised illustration.

Right to Buy - The overall cost for comparison is 8.7% APR. The actual rate will depend on your circumstances. Ask for a personalised illustration.

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