We've all heard of the word mortgage but what are the different types and does it matter which one we get? Read Findahood’s guide to find out more.
Mortgage is a French word that literally means, "death grip" but is it as bad as it sounds? A mortgage loan is used to purchase property, it is a legal agreement between a lender, usually a bank and a borrower. The amount of capital borrowed is paid back over a period of time, usually 25 years, where the borrower pays back the original loan plus interest.
Simple? Not really, there's many different ways in which you pay back your mortgage and each type suits different people.
There are six major types of mortgage which we will be exploring in depth:
With a tracker mortgage your monthly mortgage repayments amount will be determined by the base rate of interest which is set by the Bank of England. Your mortgage repayments will track an interest rate at a set margin which can range from being 1-4% above the base rate.
A tracker mortgage deal may last from as little as a year or maybe the entire duration of your mortgage.
Once the tracker deal is over, your mortgage's interest rate will be transferred to your lenders standard variable rate (SVR, you can read about this mortgage type later) which will usually have a higher rate of interest.
Tracker mortgages are great news in times of economic difficulty where the base rate, set by the Bank of England, can be as little as 0.5% like it is now. That means the interest you pay back will be low low low! As little as 1.5%.
By having a tracker mortgage with smaller repayments you could even over pay your mortgage whilst interest rates are low this means you pay it off sooner! However because of these unprecedented low base rate mortgage lenders are getting wise and may now penalise you for mortgage overpayments.
As well as going down the base rate can also go up, sometimes by a lot and it can happen suddenly without any warning.
If you're on a tight budget a sudden increase on your repayments could spell disaster. If so you may benefit from a fixed rate mortgage which we will look at next.
With a fixed rate mortgage the interest rate stays the same for a set period of time, which can be from 2 to 5 or even 10 years. After this set period your lender will transfer you to a standard variable rate (read about this one next) set by your money lender.
Each month you'll know exactly what your repayments will be which is great if you're on a tight budget. That means your repayments won't rise like a tracker mortgage even if the base rate or lenders standard variable rate does.
If the base rate drops your mortgage repayments won't drop with it unlike a tracker mortgage, so if this happens you won't benefit with lower mortgage repayments.
A mortgage with a standard variable rate means the value of repayments are not fixed like a fixed rate mortgage. The repayments are determined by a standard variable rate which is decided by the lender and can vary should they decide to.
The lender's SVR is not usually something you can sign up for it is only really applied once an introductory fixed, tracker or discount deal has come to an end.
A lender can increase or decrease its rate at any time, they tend to be influenced by changes in the base rate as set by the Bank of England but be warned even if the base rate stays the same a lender may well choose to increase their SVR.
Typically a standard variable rate tends to be about 2% above base rate but can be as much as 5% above base rate. Ouch!
Due to the base rate being at an unprecedented low rate of just 0.5% many lenders standard variable rates are also at a historic low. Borrowers who had fixed rates that started before the super low 0.5% base rates will be over the moon with their new low rate. Another reason to stay on a SVR is if your nice introductory rate has ended but you fear an expensive arrangement fee or even being accepted for a new mortgage.
These are generally what you end up on after an introductory fixed rate, tracker or discount offer has ended so they are usually uncompetitive. They are liable to fluctuations in the Bank of England base rate so could leave you with a sudden increase in monthly repayments so be careful.
With an interest only mortgage you only repay the mortgage's interest during the specified term, you don't repay any of the money you originally borrowed.
If the money you have in other investments could pay it off at the end of a term then maybe. The main reason for interest only mortgages though is when you have no interest in repaying the mortgage and owning the house such as developers who buy a house to renovate and sell on or buy to let investors who would like the investment to provide as much income as possible.
Your payments will be going to the bank and you will not end up with any of the house at the end of the mortgage term so if you plan to ever own this house then do not get an interest only mortgage.
This is called a discount mortgage as the interest rate for a set amount of time will be set below the lenders standard variable rate.
These discount deals usually last between two and five years and when the period is up your mortgage will be transferred to the lenders SVR.
Your rate of repayment will remain below your lenders standard variable rate and during economic periods of decline such as a recession your discount mortgage deal could have a low rate of interest which will decrease your mortgage repayments.
If your lender's SVR increases so will your discount mortgage repayments so you don't have much control over the amount you're paying back each month.
An offset mortgage is quite different to the above options. You offset the amount to owe the lender against your savings. So say you have a mortgage of £200,000 and you also have £20,000 in savings and current accounts. In this case, the interest is only calculated on £180,000 of your mortgage borrowing.
If you are a natural saver and have every intention of paying your mortgage off as quickly as possible then this could be for you. Often mortgage interest rates are higher than any savings accounts could earn after tax so it could be wise to have your savings offsetting your mortgage rate rather than trying to earn you interest. It also grants you great flexibility in terms of saving more to offset more of your mortgage.
Over time you will have access to a large pot of savings that is offsetting your mortgage interest. If you are undisciplined it could prove too tempting to take chunks out of your growing savings account and that could be detrimental to your mortgage repayment and home ownership.
If you're planning on getting a mortgage it pays to conduct your own diligent research into the different types of mortgages available to your and what's lurking in their small print. Hopefully with this guide you will now understand what these new terms mean to you.
Our main advice is, do not go for interest only unless you have no intention of owning the house. The only real decision left is between the variables (tracker, discount and SVR) and the fixed.
If money is tight you best take no risks and stick to the security of a fixed rate as your payments will not change for the length of the fixed rate. If you want to risk a potential rise in the Bank of England base rate and you have enough income to afford such a rise then maybe go for a tracker or discount, although in this market it is not as if the base rate is going to fall.
Once you have found your mortgage get looking for a place to live. You can use our free discovery tool to find your perfect neighbourhood. Give it a try and we wish you all the best.
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