What is a mortgage?
A mortgage is just a specific type of loan that is given in order to buy a property. Given the size of the loan, it is secured against your home to protect the lender giving it the right to repossess the property if you can’t keep up with your monthly repayments.
What types of mortgage are available?
There are several different kinds of mortgage on offer.
Fixed rate mortgages, as their name suggests, charge a fixed rate of interest for a set period of time, giving peace of mind that if interest rates increase, your mortgage payments won’t change. You will usually be charged a penalty – known as an early repayment charge (ERC) – if you want to get out of the mortgage during the fixed term.
With variable rate mortgages, however, the rate can go up or down, so your monthly payments could change over time. There are two types of variable mortgages: trackers and discounts.
Trackers are directly linked to the Bank of England base rate and the rate you are charged will mirror any changes in that. So, for example, if the base rate is 0.50%, a tracker deal might track this rate at 2.50% above it, giving a payable rate of 3.00%. If base rate rose to 0.75%, the mortgage rate would go up to 3.25%.
As with fixed rate mortgages, you will probably be hit with a penalty if you want to get out of the deal during the first few years. For example, if you go for a five-year tracker an ERC will probably apply for the first five years. The exception is term, or lifetime trackers as most of these are penalty free.
The other type of variable mortgage is the discount. Rather than being linked to the Bank of England base rate, discounts are linked to the lender’s standard variable rate (SVR). For example, if the SVR is 4.50% with a discount of 1% giving a payable rate of 3.50%. If the SVR rose to 5.50%, the pay rate would rise to 4.50%.
The problem with discounts is that SVR changes are at the lender’s discretion so your mortgage payments could change even if there has been no alteration in the Bank of England base rate. What’s more, even if the SVR changes following a move in the base rate, there is no guarantee that it will increase or decrease by the same amount.
When base rate fell from 5.00% to 0.50% between October 2008 and March 2009, for example, Lloyds TSB was the only top 20 lender to reduce its SVR by the full 4.50%. All the others cut by less.
More recently, we’ve seen a number of banks and building societies, including big names such as Halifax and Santander, put their SVRs up even though there has been no change in base rate since March 2009.
As a result, trackers are usually seen as more transparent than discounted deals and are regarded often as being fairer for the borrower.
Set up fees
Most mortgage deals carry arrangement fees, which can vary from a few hundred pounds up to a couple of thousand.
Also bear in mind that these set up costs can sometimes comprise of two fees. In increasing number of lenders charge a non-refundable booking fee which is effectively a product reservation fee. You won’t get back this back if you end up not taking the mortgage, perhaps because your house purchase falls through, for example.
The second type of fee, is an arrangement fee which you pay on completion of the mortgage so you won’t have to pay it if, for any reason you don’t take the mortgage.
Remember to always factor these into the overall cost of any deal, as even if a lender is offering a seemingly unbeatable rate, steep fees could mean that it actually works out to be more cost-effective to opt for a higher rate, but with a much lower fee, or no fee at all.
It will all depend on how much you are looking to borrow. A high fee is often worth paying in order to secure a low interest rate if you are applying for a large mortgage. But those with smaller mortgages could be better off opting for a higher rate and lower fee.
However, while this is the general rule it is well worth crunching the numbers when you are comparing mortgages. You need to work out the total cost over the term of the deal. For example, if you are going for a two-year fix you need to work out the cost of your repayments over the term: find out what the monthly payment will be and multiply by 24. You then need to add on the arrangement fee to find out the total cost.
What else you need to consider when looking for a mortgage?
Mortgage term: Most people opt for a 25-year term when they take their first mortgage out. However, you can go for a longer or shorter period of time. If you go for a longer term, your repayments will be lower but it will take you longer to pay off the debt. The shorter the term, the sooner you’ll be mortgage free. So go for the shortest term that is affordable.
And when you come to remortgage remember to reduce the term on the new deal that you apply for. For example, if you took out a two-year fixed over a 25-year term and the fixed rate is coming to an end, when you remortgage you should be aiming to bring the term down to 23 years.
Deal length: Given that most mortgage products levy an early repayment charge (ERC) during the term of deal it is important to think about how long you are happy to tie yourself in for. For example, if you think you might move in the next few years you’d be better off going for a two or three year product rather than locking into a five year product. It can cost thousands of pounds to get out of a mortgage early as the penalty is usually a percentage of the outstanding mortgage. So if your mortgage if £100,000 and the ERC is 2% you’ll have to pay £2,000.
Many mortgages are portable so in theory you can take your existing deal with you when you move. However, it is unlikely that the mortgage on your new house will be exactly the same as that on your existing home. Unless you’re downsizing, you’ll probably need to borrow an additional amount. This is possible, but it is likely to be at a different rate than you’re paying on the existing mortgage so it all gets a bit more complicated. It’s therefore simpler if the fixed or introductory term has ended and you’re out of the penalty period when you come to move.
Repayment or interest-only: You can take your mortgage out on a repayment basis or interest-only.
With a repayment mortgage your monthly payments are calculated so that you’re paying some of the capital off as well as the interest and will have repaid the entire loan by the end of the term.
Monthly payments on an interest-only mortgage on the other hand, just cover the interest. Therefore, you’ll have the original loan to pay in full at the end of the term. The idea is that you have a repayment plan in place, such as ISA investments, so that you have built up the lump sum you need by the time your mortgage ends.
However, interest-only mortgages are getting harder to come by because of fears that there is a mortgage time bomb waiting to explode because millions of people have taken them out and have no repayment plan in place. Some lenders have stopped offering them, while those that do only offer them to people with very large deposits.
How to find the best deal
Finding the right mortgage to suit your needs can be a challenge, especially with so many different deals available.
This is where Falbros can help. Our mortgage comparison service covers the entire market, and, once you’ve answered a few simple questions, it can help narrow down the field on your behalf.
If you need advice, then we’ve partnered with broker Falbros, who can talk you through the range of available options, and help you through the application process once you’ve decided on the best mortgage for you.
