Mortgage types explained

There are two main types of mortgage. These are repayment (capital and interest) mortgages, and interest only mortgages. There are several different ways of repaying interest only mortgages, and so interest only mortgages have several different options available including different investment options to pay off the mortgage, and also different types of interest rate. The savings made can differ substantially between the different types of mortgages and between the different lenders.
Repayment Mortgage

The payments you make to the lender every month pay off both the capital and the interest from the mortgage. Provided you keep up the payments, you are guaranteed to pay off the loan by the end of the term agreed (between 20 and 25 years). You usually pay off more interest at the start of the mortgage term and then gradually more of the capital debt. Therefore, in later years, you will be repaying increasing amounts of capital and reducing amounts of interest. It may seem as if this is costing more but that’s because unlike the other types of mortgages you’re paying off the capital and not just the interest.

Interest-Only Mortgages

An interest-only mortgage is where the lender only charges you interest on the loan you’ve agreed. You don’t pay the capital back until the end of the mortgage term 25 years or whatever period agreed. The idea of this mortgage is that you pay the interest owed to the lender and save the capital repayments by investing them elsewhere. At the end of the mortgage term you will have hopefully made enough money from investments to pay the lump capital sum. This way you can possibly make a saving by investing capital that would otherwise be paid straight back to the mortgage lender. The lender may offer you an investment opportunity if you choose an interest only mortgage such as an ISA. There are several different types of interest-only mortgage

Types of mortgages Variable Rate

The variable rate mortgage was, until the 1980s, virtually the only type of mortgage available. With a variable mortgage the interest rate rises and falls (varies) according to changes in the UK base rate. The base rate is set by the Bank of England and lenders are free to decide for themselves the amount they will alter their own interest rates in response to a movement in the base rate.

Capped Rate

With a capped rate mortgage you gain the security of having a ‘cap’, or upper limit, to the amount that the interest on your variable rate mortgage will rise for a specified period (typically between one and five years). If the variable rate falls your interest rate falls accordingly, although some capped rate mortgages have a ‘collar’ or lower limit below which your interest rate will not fall during the capped rate period. At the end of this period, the mortgage reverts to a variable rate.

Fixed Rate

With this type of mortgage the rate of interest that you pay is fixed in advance for a certain part of the term. Typically the period of fixed rate will be between one and five years. After this period, the mortgage reverts to a variable rate. However, there are pitfalls with fixed rate mortgages, particularly the redemption penalties that lenders may attach.

Base Rate Tracker

With a base rate tracker mortgage however, the rate of interest you pay is tied to the base rate set by the Bank of England. Typically the tracker rate will be set as a percentage above the base rate. The advantage is that if base rates fall, the tracker rates will fall accordingly, no matter how low. The downside is that if rates rise, a tracker mortgage becomes less attractive than other mortgage types.

Flexible

One of the newer facilities offered with mortgages is the flexibility to vary the amount of your repayments – both higher or lower, or even to take a repayment holiday. This flexibility can be applied to mortgage types such as variable, fixed and capped rate products and is ideal for people whose income varies during the course of the year.

Discounted Rate

With a discounted rate mortgage, you gain a percentage discount on the standard variable rate for a specified period (typically between one and five years). This counts in your favour should interest rates fall, but is not as attractive as other mortgage types if rates rise sharply. You also need to consider the redemption penalties that are sometimes attached to this type of mortgage.

Cash Back

With a cashback mortgage the lender will give you a lump sum of cash at the start – or sometimes during the term of – your mortgage. In return, you typically have to agree to take the lender’s standard variable rate, and beware also that there are usually redemption penalties attached to this type of mortgage. A cashback facility can be added to other mortgage types such as variable, fixed and capped rate products.

Non Status Mortgage (Adverse credit mortgage)

A non-status mortgage is a mortgage that is offered to borrowers who do not have to provide any proof of previous mortgage history or any proof of income. In order to cover their risks, the lenders will usually only offer non-status mortgages at a loan to value of about 70%.

Remortgage

Remortgaging is no longer something people do in desperate times. In fact it is becoming more and more popular in the UK to remortgage as often as every three years. By doing this you can take advantage of mortgage lenders discounted rates used to attract new customers.

Buy to Let mortgage

People looking for an alternative form of long term investment and in many cases an alternative to the pension have found buying to let a very desirable option. Property is an extremely good investment, but it is no longer limited to high income earners. With a buy to let mortgage you can repay the mortgage using the rental income meaning a buy to let mortgage is available to a larger number of people than you might think. however a larger sum of deposit is required this is usually around 20%- 25%.

 

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