Essentially, when you are granted a mortgage you are borrowing a set amount of money to be repaid in monthly instalments for a defined period (approximately 25-30 years.) As long as your contract allows for it, it is possible to switch mortgage providers at certain times during the life of the mortgage (which is referred to as re-mortgaging.) However, for the first time buyer trying to navigate this confusing course it can be a somewhat overwhelming process. There are some essential terms to understand:
- The Rate of interest: This refers to the amount of monthly interest you will have to pay back on the loan.
- Whether you pay back the capital and interest each month or only pay the interest (generally people choose the former.)
Each of these options comes with a number of benefits and drawbacks. The following explains the most common mortgages found to help you decide which mortgage best matches your needs.
Standard Variable Rate Deals
Description: This type of mortgage offers a discount on the amount of interest for a set period of time. Varying from a couple of months to a few years with bigger discounts being allocated to those who return to variable rates quicker, it can substantially ease the first few months as a homeowner.
- There can be many unforeseen expenses when buying a new home and it can be helpful to have a slightly lighter burden for the earlier months.
- Interest rates tend to be lower compared to the other options of the market.
- This can sometimes be the only option for those with poor credit histories
- Unfortunately all good things must come to an end and if your payments are heavily discounted it could mean your monthly instalments become far more expensive when you move over to the standard rate.
- The lender is not under any obligation to pass on any changes in the base rates
Description: This mortgage follows the Bank of England interest rate (known as the base rate)
- You are subject to the Bank of England rather than your lender so if the base rate falls, so do your repayments.
- Lenders will often “collar” this rate so interest rates cannot fall below a certain level
- A lender can take up to thirty days to pass on changes in the base rate to your mortgage repayments.
- It is important to ensure there is a cap on how high your rates can go
The level of interest you pay is fixed for a certain amount of time, usually between two and five years, this means your rates will remain unchanged regardless of changes to the base rate. After this time the rate will revert back to the standard variable rate of the lender.
- This provides a level of certainty as you will know precisely what your monthly repayments will be.
- Re-mortgaging can often be cheaper under this plan
- If the interest rates drop you could be paying more compared to the alternatives
- Often these interest rates are higher than variable rates (a trade off for the additional security)
- If you wanted to switch mortgage provider (who perhaps had better rates) you may be required to pay a hefty penalty.
- If you wanted to pay off your mortgage early, similarly you would be faced with a substantial redemption penalty.
- After a fixed period of two-five years your mortgage will return to a variable rate which may have a significant impact upon the size of your repayments.
For this mortgage the interest rates are bound to a certain degree. They can fluctuate, but only within certain parameters and they won’t go above (or below) a fixed point.
- Regardless of the base rate your rate cannot rise above a certain level
- You will receive a benefit if the base rate falls
- Due to its’ additional security, a capped rate offers rates that are often higher than other variable rate mortgages.
Capital and Interest Mortgages
As well as paying off the interest you also pay off part of the capital with each payment, it is how most people pay their mortgages.
- Interest rates tend to be lower than other options
- Allow for a level of flexibility (in certain circumstances the lender may allow for smaller repayment for a certain period of time)
- By paying back the capital you’re building up your equity which may help if you want to remortgage or borrow further money.
Interest only mortgages
Description: In this mortgage, you would only pay off the interest on the capital you owe and instead you would pay off the capital at the end of the term.
- You are paying off substantially less compared to the other option
- Only really feasible for those with who are set to earn a substantial sum of money over the next two decades.
- Relies on the value of your home increasing to cover the mortgage balance.