Understanding Mortgages

Does the word ‘mortgage’ fill you with dread?  Then you’re in the right place.  This article has been written to explain mortgages to the novice, or even the financially savvy.  We often find that even customers who enjoy organising their finances have neglected to see to their mortgage, and are overpaying as a result. 

Most of the confusion surrounding mortgages is due to the thousands of mortgage deals on the market and the fact that competition is fierce.  You only have to type ‘mortgage’ into the Internet to see the overwhelming results: Halifax mortgage, Northern Rock mortgage, Abbey mortgage, free mortgage advice, best mortgage deals, 100% mortgages, adverse credit mortgages, best mortgage in the UK…. 

These days there is a mortgage to suit everyone.  This is great news for the thousands of mortgage borrowers who were formerly unable to meet strict mortgage lending criteria and therefore unable to obtain a mortgage.  However, where does this leave someone who just wants to find the best mortgage in the quickest time?

It’s best to arm yourself with a bit of knowledge.  Your mortgage is no doubt your biggest debt, so it really does pay to look after it.  The thing to avoid is grabbing the nearest mortgage deal because you don’t have time to shop around.  A mortgage broker can do all the research for you, but before you ring it is best to have an idea of what you would like from your mortgage.

Here is some information to help you think about what type of mortgage you might like.

Firstly, a run down of the basic types of mortgage available:

Fixed rate mortgages
With fixed rate mortgages, the interest rate of the mortgage remains the same for a specified period of time – often 2 years, but it can be longer.  In recent years, the Government has tried to stimulate interest in long-term fixed rate mortgages, but borrowers’ habits indicate that they prefer not to be tied in to their mortgage for too long.   

Fixed rate mortgages are favoured by those who prefer to know exactly what they are paying each month.  Thus this mortgage is often the choice of first time buyers or budgeting families. 

Tracker mortgages
Tracker mortgages shadow the Bank of England base rate for a specified period of time, e.g. 0.03% above base rate for 2 years.  This type of mortgage tends to suit those who are looking for the cheapest mortgage deal, but who have enough scope in their budget to cope with any increases caused by changes to the base rate. 

Discount mortgages  
Discount mortgages offer a discount off the mortgage lender’s standard variable rate (SVR) for a specified period of time, e.g. 1.5% below the mortgage lender’s SVR.  Like tracker mortgages, discount mortgages tends to suit those who are looking for the best mortgage deal, but who can absorb any increases to their monthly payments.  Discount mortgages are often amongst the cheapest available deals.

Capped mortgages
Capped mortgages guarantee that your monthly payments cannot go above a certain amount, but that if rates fall significantly your mortgage payments can drop.  This type of mortgage tends to suit those that can cope with the fluctuations of a variable rate, but are also concerned about interest rates soaring.  Capped mortgages offer some security, but it’s important to note that the rate you pay at the beginning is often more expensive. 

Cashback mortgages
The cashback mortgage is a loan whereby the mortgage lender gives you a cash sum to the value of an agreed percentage in relation to your mortgage.  For example, 5% of your £100,000 mortgage gives you a cash sum of £5,000.  This type of mortgage tends to suit someone who is in need of a cash sum, but who doesn’t mind being tied to a mortgage lender for a set period of time.  With cashback mortgages, you may find that you pay a higher interest rate and that early repayment charges apply. 

Offset mortgages
With offset mortgages, your savings are used to reduce your mortgage.  For example, your mortgage is £100,000, your savings £20,000, so you only pay interest on the difference of £80,000.  You make a monthly mortgage payment as normal, but your savings work as an overpayment.  Some offset mortgages have a current account attached.

Offset mortgages are modern and attractive, but only of benefit to those who have substantial savings.  Some of their benefits are that you should be able to repay your mortgage more quickly, plus you are making use of your savings, and it is tax efficient if you are a higher rate taxpayer.  However, with offset mortgages, interest rates tend to be higher.

Flexible mortgages
The flexible mortgage is a generic term for a mortgage which allows you to do things that a more traditional mortgage would not, for example, make overpayments, take payment holidays etc.  Flexible mortgages evolved due to a need for lenders to take more unusual circumstances into account, such as those with irregular income, for example. 

With flexible mortgages, you have a mortgage to suit your financial habits but you may find that you pay a higher interest rate for the privilege.  Unless you need a particular feature which you cannot obtain elsewhere, it could work out cheaper to take a regular mortgage that has the flexible features you require.  Many mortgages now, for example, allow you to make overpayments.

So that covers the basic types of mortgage available.  Already we have narrowed the market down from some 4,000 products to 7 different types of mortgage.  To recap, you can choose from: fixed rate mortgages, tracker mortgages, discount mortgages, capped mortgages, cashback mortgages, offset mortgages and finally flexible mortgages.

Now that you know what the main mortgages are, you can begin to make some informed choices.  One of the key points to note is that mortgage lenders create fantastic new mortgages in order to attract customers.  These mortgages often have specific audiences for whom they are tailored and for whom they make financial sense.  But it is important that you find the best mortgage to suit your needs, and that you look beyond the marketing to find the actual costs involved.

Once you have decided upon which type of mortgage to opt for, you can take a look a how you are going to repay the mortgage.

Interest-only or repayment mortgage?
Interest-only mortgage
This means paying only the interest on the mortgage, whilst setting up an investment with the intention of building enough money to repay the outstanding balance on the mortgage.

Some mortgage lenders have created interest-only mortgages to attract first time buyers, enabling them to afford initial mortgage payments and then switching them to repayment after a couple of years.  This provides a means for struggling first time buyers to afford a home, particularly if they foresee an increase in their income.  But it’s important to note that the intention should always be to repay the mortgage as soon as possible.  General advice is either to opt for the repayment method or to have a sensible plan for repayment alongside your interest-only mortgage.  

Repayment mortgage
This means that you make mortgage repayments consisting of the interest and part of the loan itself.  Initially, you pay mostly interest but eventually you begin to pay off more of the loan.

Another factor to consider when looking at mortgages is whether to pay your mortgage lender daily or annual interest.  This is the method that the mortgage lender uses in order to calculate the interest you owe.  Annual calculation costs more for repayment mortgages, since you don’t benefit from the amount of the loan that you have already repaid that year.  However, interest calculation is only one part of the broader picture, so it’s best to consult a mortgage broker. 

There are a few other matters to consider when shopping for the perfect mortgage.  Let’s look at them:

Extended Early repayment charges
Mortgage lenders sometimes charge a fee should you wish to cancel the mortgage during a specified period of time.  Most of us accept that there might be a charge if we leave our mortgage within the rate-controlled period (the period during which your discount or fixed rate etc applies), but we don’t want to pay to leave our mortgage lender after that time.  Keep an eye out for extended early repayment charges and if in any doubt, ask your mortgage broker.

Higher Lending Charge
This is sometimes charged by the mortgage lender if your mortgage is in excess of 90% of the value of your home (known as the Loan To Value ratio).  You don’t gain anything from this – it just protects the lender.  So keep a look out for it.  However, do not automatically rule out a mortgage deal if the charge applies.  Again, consult your mortgage broker.

Capital raising
This term means increasing the size of your mortgage in order to release cash to spend on, say, home improvements.  This is a cost-effective short-term solution as no doubt the interest rate on your mortgage will be lower than a personal loan.  But it does mean a larger mortgage, so shouldn’t be actioned without careful consideration.

Debt consolidation
Again, here you are taking advantage of the lower interest rates of your mortgage by rolling all existing debt into one.  This is a useful means of getting out of a financial hole and with your existing debts and mortgage as one, it should be easier to take control thereafter.  However, you are increasing your mortgage so it will cost you more in the long run, therefore you may want to plan to make overpayments on your mortgage.  In addition, you are adding debts that were not previously secured against your home to your mortgage, which in the event of non-payment could mean the loss of your home.  If in any doubt, consult your mortgage broker.

Endowment shortfall
You may have read about this in the press, since many mortgage borrowers in the UK have been warned that they will experience an endowment shortfall, due to the underperformance of the investment that they set up to pay off the outstanding amount on their interest-only mortgage.

If you have a predicted shortfall on your mortgage, then one way to take positive action is to switch to repayment rather than interest-only as soon as possible.  You can then cash in the endowment policy and use it to pay off the mortgage, or hang on to the policy as an investment.

So that covers all the basic mortgage knowledge that you require.  Finally, we will look at how to access the best mortgage products on the market – by finding the best mortgage broker:

Finding the right mortgage broker
It’s all very well saying find the right mortgage broker, but that’s as confusing as the amount of mortgages on the market.  So here’s some information to help you.  Go through the mortgage section of the weekend papers, pick a few reputable national mortgage brokers named in best buy tables or in the articles, and then phone them to ask 2 key questions.

Firstly, ask if they use a panel of mortgage brokers or whether they can access every available mortgage on the market?  You will increase your chances of finding the best mortgage deal if your broker can search from the whole of the market.

Secondly, ask if they will charge you a mortgage broker fee? Many mortgage brokers charge you 1% of the size of your mortgage.  That works out at £1,000 on a mortgage of £100,000.  There is no need to ever pay a mortgage broker fee.   See free mortgage advice: our no broker fee policy.

So that’s the world of mortgages.  If you would like to learn more about the savings to be made by remortgaging or have a specific area of interest, then check out some of our other mortgage guides and articles. 

We hope that you are now in a position to pick up the phone and call us to get us looking for the best mortgage for you. 

See also:
Best buy mortgages
Online mortgage calculators
Best mortgage deal - finding the best mortgages in the UK
100% mortgages