Common Types Of Mortgages
Common Types Of Mortgages
Ray Boulger (Mortgage Advisor) gives expert video advice on: What are the pros and cons of a fixed rate mortgage?; What is a variable rate mortgage?; What are the pros and cons of a variable rate mortgage? and more...
What is a fixed rate mortgage?
A fixed rate mortgage means that you pay the stated rate of interest for a specific period of time. Normally, fixed rate mortgages run for two, three or five years. However, they can be longer; you can get fixed rate mortgages for the whole term of the mortgage. They can also be shorter; there are a few fixed rate mortgages for just a year.
What are the pros and cons of a fixed rate mortgage?
The big pro of a fixed rate mortgage is that because you know exactly what your payment's going to be for an extended period of time, you can budget and you don't have to worry about interest rate changes. Therefore, if the bank rate goes up during the time you've got your fixed rate mortgage, it's not going to affect you, at least not until you come to end your fixed rate term.The main downside of a fixed rate mortgage is the corollary of that. If interest rates go down, you won't benefit. In addition to that, you will normally have early repayment charges applying for the period of the fixed rate, and therefore should you wish to redeem the fixed rate mortgage during that term, you will have to pay an early repayment charge, which typically is between 1% and 5%. It is, however, possible to avoid that early repayment charge if you're moving house by porting, or transferring the fixed rate mortgage to your new property.
What is a variable rate mortgage?
A variable rate mortgage is one where the interest rate fluctuates with interest rates generally. Essentially there are two types of variable rate mortgage. There is one which is linked to the lender's standard variable rates, where the rate you pay will go up and down in line with the lender's adjustments to their rates. Although most lenders will change their interest rates when the bank rate changes, they don't always change it in line with the bank rate. So, the danger with a mortgage linked to the lender standard variable rate is that you actually may suffer bigger increases than rates generally, because your lender's chosen to widen the gap between bank rate and their SVR - their standard variable rate. A better option for most people is a tracker mortgage. A tracker mortgage is simply one where the rate you pay is guaranteed to be linked to the Bank of England bank rate. You will pay a specified margin above or below bank rate for a certain period of time. That means that the lender can't influence the rate they charge you; what you pay will be detected by market forces, and in particular the Bank of England.
What are the pros and cons of a variable rate mortgage?
The main advantage of a variable rate mortgage is that when interest rates fall, you will benefit and hence pay a lower amount. Likewise, when interest rates go up, you will pay more, so that's the main disadvantage. And because you need to budget for interest rates going up, you do need to make sure that you can afford to accommodate an increase in interest rates. I would suggest of up to one percent. If you can't afford that, they you shouldn't have a variable rate mortgage, go for a fixed rate. But if you do believe interest rates are likely to fall, then that will give you a cheaper mortgage rate.
What is a discount rate mortgage?
Lenders offer discount rate mortgages because they need to offer an attractive rate to actually get your business in the first place. So they will offer a discount from the standard variable rates. And that will apply for usually between two and five years. But the biggest discounts on a discount rate mortgage apply for the shorter period, i.e. for two years. And it's the same philosophy that credit card companies use to give you a low percent balance transfer rate for six or twelve months. A discount rate mortgage is a way to get your business and hope they'll keep you once they come to the end of the discount period.
What are the pros and cons of a discount rate mortgage?
As for any variable rate mortgage, the main pro with a discount rate mortgage is that if interest rates fall, you will get the benefit of lower interest rates. You need to weigh that up against the fact that your lender may not cut their standard variable rate (which is what the discount is linked to) as much as rates fall generally. In addition, you need to allow for the fact that most discount mortgages have overpayment charges that apply at least for the period of the discount and sometimes for longer. In general, I would advise people to avoid taking any mortgage that has overpayment charges that last beyond the term of the initial deal, because you will then be locked into paying a high interest rate for a certain period of time, and have no way of avoiding that unless you pay an expensive overpayment charge.
What is a capped rate mortgage?
A capped rate mortgage is a mortgage where the maximum rate that you can pay during specified term is the capped rate. You could pay less, but you can never pay more. So, as with a fixed rate mortgage, it gives you protection from interest rate rises.
What are the pros and cons of a capped rate mortgage?
The pro of a capped rate mortgage is that you're free to benefit from interest rate falls, but the degree to which you suffer interest rate increases is limited by where the cap is, so worst case scenario, you will not pay very much more, but you could benefit quite significantly if interest rates were to fall. On the down side, a capped rate mortgage would normally be compared with a fixed rate, and the cap will be in most cases at a higher level than the fixed rate. Therefore, if interest rates don't fall, you end up paying the higher capped rate for the period of the deal, and hence the fixed rate would have been cheaper. So, what you're really doing is trading off the potential to have a low interest rate against the risk that you end up paying a bit more for the mortgage period that the cap applies.
What is a tracker mortgage?
A tracker mortgage is simply a mortgage which is linked to an outside reference rate, a rate set by somebody other than your mortgage lender. Most tracker mortgages are linked to bank rate and therefore the rate you pay will be a specified margin either above or below bank rate for a given period of time. Most tracker mortgages will last for between two and five years. The cheapest will tend to be only two years, and in some cases you can get a tracker mortgage where you're paying quite a lot below bank rate, even as much as three quarters of a percent below bank rate on some of the best deals.
What are the pros and cons of a tracker mortgage?
A tracker mortgage is, of course, a variable rate mortgage, and therefore a big pro is that if interest rates fall, you will benefit; equally, if interest rates rise, you will lose out. The other major pro of a tracker mortgage, compared with a discount mortgage, is that, because the rate is linked to bank rate, you're not at the mercy of your lender deciding to change their standard variable rate by a different amount to bank rate. So, you know that your rate will always be linked to the bank rate, and therefore you will fully benefit from any falls in bank rate, and you won't have to pay more if there's any increase in bank rate.
What is a flexible mortgage?
A flexible mortgage is one where, if you make some overpayments, which most lenders allow you to do to some extent, typically to 10% of the mortgage amount, without incurring any other payment charge, you can use those overpayments on a flexible mortgage to take a mortgage payment holiday, which means you could completely miss one or more months' mortgage payments, or make underpayments, where you pay less than the normal amount, or borrow the money back as a lump sum. So if you have that facility within your flexible mortgage, it does mean that you can make more overpayments than you might otherwise be comfortable with because you know you can get the money back if you need to. But different mortgages allow different degrees of flexibility, and so you do need to understand clearly how much flexibility is offered with any particular mortgage.
What are the pros and cons of a flexible mortgage?
The big pro with a flexible mortgage is that because you've got the ability to borrow money back in different ways, if you need to, you can afford to pay more of your savings into the mortgage and hence reduce the interest rate you pay, knowing that you have access to that money if you need it. The degree of flexibility offered by lenders varies quite considerably and if you want total flexibility, i.e. the ability to borrow money back as lump sum, then the choice of mortgages is relatively small and you may therefore pay a higher interest rate for that. So, the key thing to look at is how much flexibility you need. Don't pay extra in terms of a higher rate of interest for flexibility that you won't use. But if you will use the flexibility, it may well be worth paying a higher rate of interest for that benefit.
What is an offset mortgage?
An offset mortgage is a mortgage where in addition to the actual mortgage you have a current account and or a savings account linked to the mortgage. Each day the lender calculates the net balance owing to them, i.e. the difference between the money in your savings or current account and the mortgage balance, and charges you interest just on that net balance. So, for example, if you have a mortgage for £200,000, and you have £10,000 in your savings account, you're only charged interest on £190,000. Despite that, the money in your savings account is always fully available to you so you have immediate access to it. Clearly, however, if you withdraw money from the savings account, you with then be paying more interest on the mortgage. It's very tax efficient because if you were to receive money on your savings interest, then that would be taxable. In addition to that, the interest you are paying on the mortgage would, in most cases, be higher than the interest you receive on the savings. So, by netting off the interest between your mortgage and your savings account, you effectively get a higher rate of interest on your savings, which is tax free. So, it's a very tax efficient way to use your savings whilst still keeping full control of them.
What are the pros and cons of an offset mortgage?
The big pro with an offset mortgage is that is a very efficient way to use your savings. It's particularity useful for people who have a volatile cash flow. So for example, an offset mortgage would be advisible for somebody who is self employed, and needs to put money away to pay their tax bill every half year; for somebody perhaps who is employed, but gets large bonuses, particularly if the bonuses are paid on an annual basis. The spare cash can go into the linked savings or current account and then that can be immediately available when it is needed. As far as the cons are concerned, the main disadvantages are that you may pay a higher rate of interest than on a non-offset mortgage because there is less choice, although competition in the market means that now there are some very good offset rates available for two years. If you want a fixed rate, there is much less choice in the offset market. So if you do want a fixed rate mortgage, then you need to consider very carefully whether an offset is the right solution because you may pay about a half percent higher rate of interest than you would on a non-offset mortgage. Therefore, you have to juggle with the finances to work out whether it is worth paying a higher rate of interest to get the benefit that you would get from the offset mortgage.
What is a current account mortgage?
A current account mortgage is essentially a huge secured overdraft which you would use in the same way that you would use your ordinary current account, i.e. to have your income paid in and your outgoings going out. However, the amount you borrow is secure in your property. You would get a monthly statement as you would with a normal current account, and a lot of people don't like that because, psychologically, to have a statement showing that you've got a huge secured overdraft (perhaps £200,000, perhaps more) is not very comfortable, and that's why current account mortgages are actually not offered by many lenders.
What are the pros and cons of a current account mortgage?
The main pro of a current account mortgage is that by having all your savings and all your income going into the mortgage account, you pay less interest each month, and therefore the more you can save, the less interest you pay. Equally of course, when you take money out of the current account, you pay more interest. The biggest con really, is that people don't like seeing a huge secured overdraft; each month they will get a statement from the lender perhaps showing a balance of £200,000, and that can be quite scary. People generally like to keep their mortgage separate from their savings, and they can do that more easily with a different type of mortgage such as an offset mortgage, which still achieves the same principle as a current account mortgage but in a better way psychologically. In addition to that, the interest rate charge is quite high because only a couple of lenders provide a current account mortgage, so you would pay a high rate of interest on a current account mortgage, which in most cases more than outweighs the benefits.