Further information
'Tracker,' 'discount,' self cert,' 'sub prime.' These are just some of the mortgages that you may come across if you search for a new mortgage online or visit a mortgage broker for advice.
With a dozen or so different types of mortgage available and hundreds of variations on each type, you could be forgiven for being confused, but with a little homework you could be a mortgage expert in no time and save yourself hundreds, if not thosands, of pounds off your mortgage payments.
Different types of mortgage
A mortgage is simply a large loan secured against the value of your home and is usually repayable over 25 years.
When taking out a mortgage, you can usually borrow at least three times your annual income, although your lender may be willing to lend you more, depending on your circumstances and income. Although the term is generally 25 years, it can be for as short a term as ten years.
You will usually need a deposit and the more you can put down the better. That said, most lenders will offer a mortgage to 95 per cent of the property value, and some will even provide 100 per cent mortgages.
Borrowing 100 per cent of your property's value is clearly risky. In the event that house prices fall, your home could be worth less than your mortgage - a phenomenon referred to as 'negative equity.'
Also remember that a mortgage is secured against the value of your home so that if you fail to maintain your repayments, the lender can start repossession proceeding after just three months of arrears.
There are two main ways you can repay your home loan, via a :
- repayment mortgage, or
- an interest only mortgage
Repayment
This involves paying back the capital and the interest of your mortgage on a monthly basis. Although this will be more expensive than an interest-only mortgage, you have the peace of mind of knowing that at the end of the term, you will have repaid the mortgage in full.
Repayment mortgages provide certainty of capital repayment and are not dependant on the investment returns of a savings scheme.
Interest only
This means you pay off only the interest on your mortgage each month and nothing towards the original lump sum, or 'capital,' you owe.
With an interest-only mortgage, you need to set up a savings plan, such as an ISA, the proceeds of which can be used to pay off the mortgage.
When house prices are high, an interest-only mortgage may be the only affordable option for some buyers, but this should not be an excuse to ignore the need to put in place a saving scheme to run alongside the mortgage.
You are taking a risk with an interest-only mortgage. While your savings plan might perform well and you could end up with some cash left over once you have paid off the mortgage, the scheme could just as easily fall short, leaving you with an outstanding debt and no way of paying it off.
ISAs are a good way to save as they are tax efficient but you should take advice on choosing suitable shares or mutual fund to place within them.
Some people who opted for endowment policies in the 1980s and 1990s experienced disappointing returns and had significant a shortfall when they came to pay off their mortgages.
Do not fall behind on payments to your ISA or whatever other investment scheme you put in place. It is up to you, not your lender, to make sure you maintain payments.
With choice comes complexity. Although the choice of mortgages may seem daunting, the UK mortgage market is highly competitive and there are excellent deals on offer, if you are prepared to take advice and shop around for a good deal.
Standard variable rate
This will move up and down with moves in the Bank of England base rate. At the time of writing (mid April 2007), Halifax's Standard Variable Rate was 2 per cent over base rate or 7.25 per cent. Some lenders charge nearly 2.5 per cent over base rate, so accepting to pay your lender's SVR is an expensive choice.
If you have been on a special deal, your mortgage rate will normally revert to your lender's SVR at the end of the discount period, so it is a good idea to shop around for a new deal a few months in advance.
Fixed rate
If you think BEBR is going to continue rising for some time, it may be a good idea to take out a fixed rate. By contrast, if you think base rate is at or near its peak for the time being, a fixed rate might lock you into an uncompetitive rate as base rate falls.
If you are on a tight budget , you may want the peace of mind which comes with knowing what your monthly payments will be for a set period of time, usually 2 to 3 years, so a fixed rate mortgage may be suitable.
Some lenders offer long-term fixed rates which some people find attractive because they like the idea of knowing what their rate will not change for the next 20 years.
But if rates were to drop to an all-time low, you would miss out because early repayment charges (ERC) normally apply if you want to get out of a fixed rate deal before the end of the fixed rate term.
Discount rate
These mortgages offer a discount off the lender's SVR. Although the initial rate may look attractive, remember that the rate is variable and will go up and down with the SVR, which will in turn move in line with base rate.
At the end of the discount period, your mortgage will normally revert to your lender's SVR.
Capped rate
This charges a variable rate, but with a cap which the interest rate cannot exceed. This means that although your interest rate will move up and down with the base rate, it cannot exceed the capped rate. This means that you will benefit from all falls in base rate, but rises will be limited by the cap.
Make sure you do not confuse the initial pay rate with the capped rate.
Tracker
These mortgages are charged at a fixed margin above or below base rate and move up and down when the base rate changes.
The advantage of a tracker mortgage is that the rate fluctuates in line with base rate and because the margin you pay below or above base rate is fixed at the outset, your lender cannot play around with this (as it can with the margin between base rate and its standard variable rate).
For instance, a few years ago, the margin between base rate and the typical SVR was typically 1.75 per cent. Today it more likely to be 2-2.5 per cent over base rate which at the time of writing was 5.25 per cent, making SVRs typically 7.25-7.75 per cent.
Offset
With this type of mortgage, you place your savings in an account with your lender and the balance of your mortgage is then reduced by this amount. So, if your mortgage is £100,000 and you have £5,000 in a savings account with your lender, your mortgage balance will be treated as being £95,000 and you will only be charged interest on that amount.
As your savings are being offset, you don't have to pay interest on them which is why offset mortgages are more suited to higher rate taxpayers. Offset mortgages also allow you to make large lump sum payments so these mortgages are often recommended to people who expect to receive large bonuses, commissions or who have a fluctuating income.
By offsetting your mortgage balance against your savings, you will pay less mortgage interest, less tax and if you make overpayments from time to time, you will pay off your mortgage more quickly.
Buy to let
More and more people are recognising the benefits of buying properties for renting. Investment in rental property is so popular now that most lenders offer special Buy To Let (BTL) mortgages charged at little more their standard mortgages.
The rental income should cover the mortgage payments and leave some spare cash to cover repair and maintenance, voids (when the property is empty) and other property related bills.
Being a landlord is a serious and time consuming business so you should take advice before entering this market. For more on buy to let, read our guide:
Most lenders will lend up up to 75-80 per cent of the property's value and you will need income rental covering 125-130 per cent of the mortgage repayments. Some lenders will lend you more which is fine providing you are not dependent on the rental income to cover the mortgage repayments and other expenses. There are many different types of BTL mortgages, from fixed to discount and trackers.
It is normally advisable to take out an interest-only BTL mortgage as the interest can be offset against the income tax liability on the rental income. If you have a large mortgage, the interest (and other tax deductible expenses) may reduce or wipe out your tax liability.
Flexible
There is much greater flexibility in mortgages these days, with many incorporating the facility to make overpayments, underpayments, take payment holidays and which charge interest on a daily basis.
Daily interest repayment is the most beneficial for borrowers as your debt is reduced on a daily basis, rather than a monthly or annual, basis. Having the interest you pay applied on an annual basis, is basically a rip-off as none of your payments throughout the year are actually reducing your mortgage debt.
Sub prime
If your credit history is patchy, you may have difficulty in obtaining a 'prime' mortgage (for those with clean credit histories and who can therefore secure the best rates).
A poor credit rating will apply if you have ever had mortgage arrears, been bankrupted, have a County Court Judgement/s (CCJs), defaulted or made late payments on any loan or hire purchase agreement.
However, there are special mortgages for people in this position called sub prime mortgages, although you may have to pay a higher rate than for a prime mortgage.
Self certification
Self-employed people are asked to self certify their earnings and may have to pay a higher interest rate. This is because of their fluctuating earnings and the perceived higher risk of the self employment.
Proof of earnings is usually required in the form of trading accounts for the previous three years. But always check whether you can get a standard mortgage as some lenders may be willing to treat the self employed with plenty of equity and other sources of income as a standard risk.
Fees
Taking out a mortgage is an expensive business, but by shopping around you can reduce the costs.
These include the administration or arrangement fee, valuation fee, legal fees and sometimes a mortgage indemnity guarantee (MIG), now called a higher lending charge. The latter applies only if have a very small, or no, deposit.
However, some lenders will contribute towards valuation and legal costs as a way of drumming up new business. Valuations in particular may be refunded or discounted as an incentive and some will pay all your legal fees, although this may require you to use a solicitor of your lender's choice.
Early repayment charges (ERCs)
Many products with low introductory rates carry early repayment charges to stop you moving before the offer period ends. Some lenders even charge 'overhang' ERCs for one or two years even after the discounted deal has ended. Avoid mortgages with higher lending charges if you possibly can.
Free valuations and legals may look attractive but check that you are not paying a high arrangement fee or interest rate to pay for these sweeteners.
Buildings insurance
This is a compulsory insurance and some lenders will try to sell you their own buildings (and contents) insurance because insurance companies pay them huge commissions for selling their products.
It is illegal for a mortgage lender or estate agent to force you to purchase building insurance with a mortgage, although some may try to give you the impression that it would be in your interests to do so.
Some lenders will also offer you mortgage payment protection insurance (MPPI), which will cover you for accident, sickness or unemployment (ASU).
It is highly advisable to reject these offers and to take independent financial advice to get a better deal elsewhere. You may be better off taking out income protection insurance which will pay you an income if you are unable to work at any time up to retirement, and not just for a few years. For more on home insurance, read our guide:
Don't over extend yourself
While there are checks and balances in place to try to prevent people borrowing more than they can afford, it important that you, the borrower, are honest about your annual income.
If you over commit yourself, you could find the repayments impossible to service and at worst, find your home is repossessed by the lender, or get a criminal record for fraud if you have lied about your income.
Annual Percentage Rate (APR)
Lenders are obliged to quote this and it should reflect the interest rate, plus any associated costs so that you can compare like with like.
Even if you are not moving house, you may well find that changing to a different type of mortgage with your existing lender or remortgaging with a new lender could mean big savings over the years.
Home information packs
From 1 August 2007, anyone putting a property on the market with four bedrooms or more must have a home information pack in place.
The pack must include:
- An index of the contents of the pack
- Evidence of Title
- Sale Statement (which must summarise the terms of the sale)
- Standard Searches (ie local, drainage and water)
- Commonhold information (if applicable)
- An Energy Performance Certificate
- Leasehold information including a copy of the lease and information on service charges and insurance (if applicable)
- New home warranty (if applicable)
- Where appropriate, a report on a home that is not physically complete.
- If the property is Commonhold, then the commonhold information (including a copy of the commonhold community statement)
- The authorised documents include:
- Guarantees and Warranties
- Other searches
The pack is expected to cost vendors around £300-£500.
Further information
Last edited April 2007
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