Mortgage Introductory guide
Introduction to Mortgages
6 essential points to understand about mortgages
There are around 7,000 mortgage products available to you provided by over 100 different lenders. Therefore choosing a mortgage can be a daunting process.
Please remember when choosing a mortgage, that there is no one cheapest or “best” product. You have to sort a mortgage which suits your needs, your lifestyle and your finances, again the key to buying a property correctly and financing yourself correctly is by understanding your own needs.
Point 1:- What is a mortgage?
Mortgages are a type of long-term borrowing. Typically, you might borrow for a ‘term’ of 25 years. But you can take out a mortgage with a shorter (or longer) term.
You can pay off some or all of the loan before the end of its original term (though there may be a charge if you do this – see Mortgages – charges).
You can switch from one lender to another – called ‘remortgaging’.
There are two basic types of mortgage:
- Repayment (also called ‘capital and interest’). Your monthly payments pay the interest and also repay part of the amount you borrowed (called the ‘capital’). Provided you make all the agreed payments, the whole loan is paid off by the end of the term;
- Interest-only Your monthly payments pay only the interest. You don’t pay off any capital until the mortgage comes to an end. To make sure you have the money to do this, usually you also make monthly payments into an investment plan, such as an individual savings account (ISA) or endowment policy (and these types of mortgage are commonly known as ‘ISA mortgages’ and ‘endowment mortgages’). The plan grows to provide a lump sum by the end of the term which, hopefully, is enough to repay the loan. Whether it is enough depends on stock market performance. So interest-only mortgages are not suitable if you are uncomfortable with investment risk.
Point 2:- The different types of Interest Rates explained
Lenders use different types of interest rates across their mortgage product range. The following types of interest rates are fairly common:
- Standard variable rate? (SVR)
The lender’s main rate. ‘Variable’ means it goes up and down broadly in line with general interest rates.
- Tracker
Designed to fall – and rise – in line with a rate or index such as the base rate set by the Bank of England.
- Discounted rate
A set amount off the lender’s standard variable rate for the first few years of the mortgage. Useful because the mortgage is cheap at a time when you may be facing lots of extra costs, such as moving expenses, buying furniture, and so on.
- Fixed rate
The interest rate stays the same for a set number of years. Useful because it helps you to budget with certainty, but you could lose out if variable rates fall while your rate is fixed.
- Capped rate
This is a variable rate that goes up and down in line with interest rates generally but never rises above a set level (the ‘cap’). Useful because it helps you to budget and still allows you to get the benefit of any falls in interest rates.
Point 3:- Percentage Rate or APR explained
The APR is a way of comparing the total cost of different loans over the whole term, say, 25 years.
The APR takes into account:
- The interest you must pay.
- Certain other charges you must pay – for example, an arrangement fee.
- When and how often you pay the interest and charges.
- You do not need to know how to work out an APR. The important thing is that APRs show the cost of borrowing on a standard basis. So you can compare one APR with another. It might seem obvious but a loan with a lower APR is generally cheaper than a loan with a higher APR.
Lenders must show the APR in most advertisements and in quotes for mortgages.
The APR also lets you compare the cost of a mortgage with other types of borrowing.
Point 4:- Beware mortgage lenders additional charges
The APR for a mortgage does not always tell you the whole story because:
- Some charges are not included – for example, premiums for buildings insurance that you must take out through the mortgage lender to get a special deal.
- Charges that you only might have to pay are not included – for example, an early repayment charge if you pay off part or all of the mortgage in the early years or before the end of its term.
- If you have an interest-only mortgage, the APR does not include the monthly payments you make to any investment plan that you intend to use to pay off the amount you have borrowed
Point 5:- What are early repayment charges?
Early repayment charges are made when you pay off (redeem) all or part of your mortgage before the end of the mortgage term. They may be charged in the following situations:
- You switch to a different lender.
- You switch to a better deal from your existing lender.
- You pay a lump sum off of your original loan.
- Move to a cheaper property and reduce the size of your mortgage.
- You sell up and pay off your entire mortgage.
You should check your mortgage key facts document carefully to see if early repayment charges can be made and, if so, under what circumstances. If you are happy to agree to a mortgage that ties you in for a set number of years, check whether early repayment charges apply after the initial deal ends.
How big are the charges?
They are typically worked out as a percentage of the amount you repay, a percentage of the amount you borrowed or a number of months’ interest. Whatever method is used, it can lead to a large charge
Charges – other points to bear in mind
Other features of a mortgage that affect the amount you pay include:
- Repayment mortgage
- How often interest is calculated by the lender
- With a repayment mortgage each payment you make consists of interest and some of the capital (the loan). If interest is calculated monthly it takes account of the capital you have repaid up to the last month. This reduces the amount of interest you pay on the loan compared with mortgages where the interest is calculated yearly.
- How your payments are treated if you pay off a chunk of your loan or regularly pay extra each month. With some mortgages, overpayments only reduce the mortgage balance once a year so they take a long time to affect your interest payments. Other mortgages deduct overpayments from your balance straight away, which means you get the benefit immediately.
Point 6:- Understand other Mortgages
Some mortgages are marketed as flexible mortgages.They are designed to allow you to make extra payments whenever you want to and benefit immediately. Some also let you reduce your payments or take a payment holiday.
Another variation is the all-in-one mortgage or offset mortgage where you have your current accounts and savings with your mortgage lender. Your mortgage interest and monthly payments are then worked out based on your mortgage balance less the balances in your current and savings accounts. The higher your savings, the less you pay for your mortgage.
