Mortgages Explained

What is a mortgage?

A mortgage is a loan that is secured on a property, and is also known as a home loan. A mortgage is usually acquired from a lender to buy residential property. However it is becoming increasingly popular for existing homeowners to switch mortgage lenders without moving home - this is known as remortgaging.

What are the different types of Mortgage?

Fixed Rate

The monthly interest rate will stay the same for a set period of time, for example, between 2-5 years. At the end of the fixed rate period your rate will usually change to the Variable rate.

Advantages

You are guaranteed that your rate will be exactly the same every month for the duration of the fixed rate term – even if other interest rates rise during this period. You can confidently plan your budget for the whole period, because you’ll know in advance exactly what your major outgoings will be

Disadvantages

If other interest rates fall during the set period, then the amount you pay during the fixed rate term may be higher than if you had chosen a mortgage type where the interest rate is allowed to rise and fall.

The Variable Rate

The 'Variable' rate for the purposes of our Mortgage Guide, means either the lender's standard variable rate (SVR) or those rates which track an external rate (such as the Bank of England base rate or LIBOR) or tracker rates. 'Variable' means the rate can go up and down.

Advantages

The rate you pay may fall if mortgage rates in the market fall - this means your payments may go down. A variable rate without any special incentives may allow you to repay some or all of your loan without having to pay early repayment charges.

Disadvantages

Your payments may increase if mortgage rates rise. So unless you can afford increases in your payments, you may be better off with a mortgage where the rate is fixed for a period of time (giving you time for your income or earnings to increase).

Capped Rate Mortgages

Your payments are linked to a Variable rate which means that payments may go up or down - but the amount the rate can rise to is restricted to an upper limit (known as the 'cap' or 'ceiling') for a set period of time. There is a similar mortgage called a Cap and Collar Mortgage, where the rate you pay does not fall below a lower limit (known as the 'collar' or 'floor'). At the end of the cap (and/or collar) period you are usually charged at the Variable rate.

Advantages

These mortgages provide certainty that the Variable rate charged to your mortgage will not rise above the cap. This means you are protected from significant rises in Variable rates. This will help you to budget. In addition, you will be able to enjoy a lower rate if interest rates fall.

Disadvantages

May not be as beneficial as a fixed rate mortgage if rates rise, as the upper limit of a capped rate is often higher than a fixed rate. For example, if the Variable rate rises to the cap level and remains at this level for a significant period of time, then a fixed rate mortgage below this level may have been better value.

Discounted Rate Mortgages

Your payments are based on a discounted rate set at a certain level below the Variable rate for a specific period of time, which means your payments may go up or down. For example, a 1% discount for 12 months off a Variable rate of 5% would mean a pay rate of 4% for 12 months. Sometimes these discounts are stepped over a period of time, for example, a discount of 2% in year one followed by a discount of 1% in year two. After the set period the Variable rate usually applies.

Advantages

Provides you with lower payments in the early years to help with the cost of moving or setting up in your new home. A discount that gradually reduces means you do not usually face a significant increase in payments when the discount period ends.

Disadvantages

If interest rates rise whilst you are on a discount, your payments may increase.

Cashback Mortgages

Instead of receiving a discount, you receive a single lump sum or cashback generally based on the value of your loan at the time you take out your mortgage. For example, on a £100,000 mortgage with a 3% cashback, you will receive £3,000. Your monthly payments are usually linked to a Variable rate, which may go up and down in line with interest rate changes.

Advantages

It means money in your pocket at a time you may need it most. It can provide you with a very useful contribution to the cost of moving, or helping you pay for the decorating and refurbishment work you may have planned for your new home.

Disadvantages

Because of the lump sum you receive at the start of your mortgage, your rate may not be as attractive as some other mortgage types. The cashback you receive is not usually available to use as a deposit on your mortgage, as it is only generally available after you complete.

Tracker Mortgages

Your interest rate is directly linked to an independent rate, such as the Bank of England base rate or the 3-Month LIBOR (the London Interbank Offered Rate) for a set period of time. For example, your rate may be 1.5% over the Bank of England base rate for a period of three years.

Advantages

Your rate will reflect the independent rate being tracked. This means when the independent rate falls, you are guaranteed to benefit from the rate reduction in full at preagreed times.

Disadvantages

If the independent rate rises, your rate will automatically rise so you may find you are paying a rate which is higher than other variable rates.


'YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE’