Choosing a mortgage can be really difficult, particularly if you are borrowing for the first time. It is a big commitment and although it is possible to swap lenders, it is wise to work hard to make the best decision that you can. Before you can start it is important to understand about the different types of mortgages.
A variable rate mortgage is what most people with mortgages hold. The rate will change when the lender wants it to. Typically they will change it when interest rates change and what you pay will change. They are more likely to raise the rate when interest rates increase than they are to lower the rate when interest rates decrease though. The variable rate tends to be a few percent above the base interest rate but it can vary a lot between lenders. It is wise to not only compare the current rates between lenders but see whether you can find out how they compared in the past. This will help you to see whether they have always been at this place in the market. If they tend to be expensive compared to other lenders but have recently become cheap then this may be a temporary reduction to draw in new customers. It can be worth asking them to see whether they can explain it.
The good thing about a variable rate is that it can come down when interest rates fall but it will rise when they go up. You will not know what you are paying each month as the rate can change regularly. This can lead to some uncertainty as to whether you will be able to afford the repayments in the future. As mentioned above the rate may also go up when base rates rise but not fall when they fall. To protect against this you can opt or a tracker mortgage which will charge you a fixed percentage plus the base rate so it will constantly track changes.
A fixed rate mortgage has a certain period where the rate is fixed. It is possible to fix for the whole term of the mortgage but this is not common with UK buyers. Usually the rate is fixed for one, two, five or ten years. This helps borrowers to know exactly how much they will be paying each month. This can be particularly critical at the start of a mortgage term when the borrower may be stretched financially and find it difficult if payments went up. As the years go on, it is likely that they will earn more and so the mortgage repayments will be less of a burden. The problems with fixed rates come when interest rates fall and then the borrower will not benefit from the savings that that could bring for them. If you want to move house while you are still in your fixed rate then this may be problematic unless you have a portable mortgage. Therefore make sure that you check the terms before you sign up if you think that this is likely to happen.
Fixed vs Variable
Choosing between fixed and variable will be a personal decision depending on your circumstances. However, at the moment interest rates are historically low and unlikely to fall any more. This means that any variable rate is likely to increase and not decrease. When this will happen though is open to speculation and if you fix your mortgage rate for a year, you may find that rates stay the same and you would have been better off with a variable rate mortgage. However, it does seem likely that rates will rise in the next five years and most likely in the next ten. Therefore fixing for a longer term could be wise. However, you will initially be paying more for a fixed rate and so you will need to calculate whether you think you will be better off this way. If you want to move mortgages while you are in a fixed rate period then there could be high costs, so it is wise to make sure you get one that you feel will be competitive so this does not need to happen.
A repayment mortgage charges you monthly for both the interest and a chunk of the balance. This means that over the term the amount that you owe will decrease and at the end you will have nothing left to pay. These are favoured by people who want to see their debt being whittled away and have concerns about investing money to pay off the mortgage. A repayment mortgage can be more expensive but at least by the end of the term, you will have nothing left to pay. Also if you want to remortgage it can be cheaper to have a repayment mortgage, because you no longer owe so much money, so may be able to get more competitive rates.
With an interest only mortgage you will only have to pay the interest back that is owed each month. The balance is left outstanding until the end of the term when it is expected that you pay it off in full. In the past, many people took out an endowment policy to invest their money so that they could pay off the mortgage. However, when there were problems with the stock market in the 1980’s many found that there was not enough money in their endowment to cover the cost of the mortgage and this meant that they had to find extra money to pay it off. This put a lot of people off using an interest only system. However, there are other ways to invest your money in order that it grows enough to pay off the mortgage. A financial advisor will be able to help you to pick the right option for you, if you are not confident in choosing one. There have been people who use an interest only mortgage but invest no money to pay off the loan. This is against the rules of the mortgage and means that at the end of the term, they will have to sell the property to repay the loan. This can work as long as the property sells and is worth more than the value of the mortgage but it leaves the borrower with nowhere to live.
In the UK interest only mortgages are now difficult to get. Unless you can prove that you have a good plan to make the money that you will use to repay it you will be refused. This is for the regulator who now insists on this to prevent people being left without any funds to pay off the loan at the end of the term.
Repayment vs Interest Only
This decision can be quite a personal one. If you hope to invest money and get enough to pay the mortgage off early then an interest only mortgage could work for you, but you will need to prove to the lender that you have a good plan in place. However, if you want to just know that you are paying a small amount back each month, then the repayment one is better. Financially is it quite difficult to calculate which will be cheaper. It depends on what return you get on your investment and how interest rates behave. A financial advisor would be able to show you some statistics so that you can work it out with them. It is not as simple as comparing one type to another because different lenders calculate interest in different ways and have different fee structures. Also investment values will change depending on how much risk you are prepared to take.
An offset mortgage allows you to run a savings account and possibly a current account alongside the mortgage. The interest on the mortgage will be calculated based on the combined balance of the three accounts. This means that if you like to have savings and have quite a few, it could lead to the mortgage interest charges being lower. This is seen as an advantage to making early repayments because the money is accessible if you need it. However, the interest rate can be higher on these sorts of mortgages. The current account mortgage is rare now as it meant that the current account balance was always a huge negative one and people did not like seeing that, but if you have a lot of money going through the account then it could make a big difference to the overall cost of the mortgage as interest charges will be lower.
If you want the option to pay the mortgage off early then make sure that you check that you can. Some mortgages are more flexible than others and some will have quite high charges for this service. Paying the mortgage back early can save you a significant amount of money especially if it is years early. There may be a fee to pay if you repay it in full early, even if you have the option of early repayment. This fee is unlikely to be as much as the money you will save in interest over the remaining term but do the calculations. Work out how much you pay in interest each month and how much you will save, assuming interest rates remain the same, if you pay it back early. Then compare that to the fee and see whether you will save money of not. With interest rates very low at the moment, the savings to be made are lower than they would have been in the past.
This is a special type of variable rate mortgage where you have a discounted rate for a specified number of years before moving onto the standard variable rate. This can be helpful as it keeps the costs lower for a few years and often those first few years after buying a home can be expensive. However, if interest rates rise, your rate will too as it is just a percentage discount off their rate, not a fixed rate. You will therefore need to decide whether you think that this is a good deal compared to a fixed rate. In order to work this out you need to make a prediction as to what interest rates might do in the future, which is not easy.
We often hear about mortgages being flexible, but what does it mean and is it right for you? The term may mean different things to different lenders, but it is likely to mean that you can make overpayments on the mortgage. You may have some spare money and want to put it against the mortgage and this will allow you to do so. However, you may not be able to get it back unless you have an offset mortgage with an associated savings account that is instant access. A flexible mortgage may also allow you to borrow back money that you have overpaid. They do not all offer this option though. They may also allow you to have payment holidays if you need them. Check the terms of these though. You will have to negotiate this even if it is in your terms and they still may not allow it. The interest will also be accumulating and your future repayments will be raised to cover the missed payment and there may be fees on top. Some lenders will only allow a payment holiday if you have overpaid at some point in the past. So treat these with caution and make sure that you know exactly what you are allowed to do and how much it will cost.
Deciding on which type of mortgage is right for you can be a very difficult decision. Many people seek financial advice in order to help them. It is important to make sure that you understand what all of the different types of mortgage are and what options you may have within those. Make sure that you have a thorough understanding of the mortgage before you sign up including all of the fees and terms.