MoneySavingCentre - Mortgages Explained
There are two main methods available for the repayment of your mortgage.
These are:
You can also use a combination of interest only and capital and interest repayment methods to repay a loan. Always remember: it is your responsibility to ensure that you have an adequate repayment vehicle in place to repay the mortgage at the end of the term. If you do not make suitable arrangements, you will be responsible for the amount outstanding at the end of the mortgage term.
Capital and interest Mortgages
These are also referred to as Capital Repayment Mortgages. Capital is paid back gradually every month over the term of the mortgage. At the beginning of the loan, interest is charged on the full amount of the loan and the monthly repayments are mainly interest charges. As the loan progress, however, more and more capital is repaid and the interest charged steadily decreases. During the latter stages of the loan, payments are mainly capital repayments. The level of monthly repayments will increase or decrease in line with interest rates. If you are a cautious person, then as long as you keep up all the payments, this method will guarantee that the mortgage is repaid at the end of the term. It is also usually possible to both increase and decrease mortgage payments within certain limits as determined by the lending source, including repaying lump sums of the amount outstanding.
Interest-only Mortgages
With an interest-only mortgage the borrower agrees at the outset of the contract that only the monthly mortgage interest will be paid to the lender. The monthly payment does not reduce the capital or principal mortgage amount and will be affected by interest rate changes, increasing or decreasing in line with those changes. Following a change in the rate applicable to your account, you will receive a letter advising you of the revised payments. Because the payments are intended to pay only the interest, the balance of your mortgage is not reduced and the full capital amount becomes due at the end of the agreed loan period. Most people need to contribute to an acceptable investment vehicle that will repay the capital at the end of the loan period. To adopt this method of mortgage repayment you need to be prepared to accept the risk that the value of your investment will be sufficient to repay the loan amount at the end of the mortgage term. It is possible to take out a true interest-only mortgage and not put in place an investment vehicle to repay the capital at the end of the term. Your home is at risk however if you choose an interest only mortgage but do not establish adequate provision to repay the loan at the end of the agreed term. There are many types of investment plans that can be used to repay an interest-only mortgage: each type has its benefits and drawbacks. The main types are: Individual Savings Accounts (ISAs), Endowment and Personal Pension contracts. It is wise to consult a suitably qualified individual such as an Independent Financial Adviser before entering into any investment contract.
Most lenders will offer a range of products to which a number of different interest rate options may be applicable. These are in alphabetical order as follows:
Capped Rate
This is where your interest rate is capped for a specified period and during that period the interest rate you are paying will not go above this figure, no matter what the lender’s variable rate. However, your repayments will still fall in line with any reductions in the variable rate. There may be an arrangement fee and there may be an early redemption penalty (redemption means paying off your loan).
Cashback Mortgage
These are usually given as an incentive to new borrowers. The amount of cash given on completion of the mortgage is usually based on a percentage of the amount borrowed. The interest rate is usually variable with Cashback mortgages. In return for receiving the cashback, the lender stipulates a period of time that the mortgage must be held. If the mortgage is redeemed during this period, the lender will ask for the cashback to be repaid.
Discounted Rate
The interest rate applicable to your loan is reduced by a specific percentage for an agreed period. Repayments will always be less during this period. However, they can still rise or fall with interest rate changes. There maybe an arrangement fee or an early redemption penalty.
Fixed Rate
The interest rate is set for an agreed period. This can be for 1 to 10 years or more. At the end of the agreed period, the interest rate will revert to the lender’s standard variable rate at that time. Fixed Rate mortgages offer peace of mind, since you are protected against rising interest rates and have the comfort of knowing exactly what your repayments will be during the initial fixed rate period. However, should the variable rate fall below your fixed rate, you will continue to pay interest at the fixed rate and your payments will be higher than they would have been on the variable rate. There is normally a redemption penalty in the early years.
Flexible Mortgage
The flexibility is that the payments may be varied to suit your situation. You can make savings on interest payments, or even pay off your mortgage early and own your home sooner. As interest payments fluctuate in line with interest rates, any underpayments or payment holidays are likely to be added to the outstanding loan which will mean you will be required to increase your mortgage payments in the future.
The key points to note with regard to Flexible Mortgages are as follows:
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Overpayments - You are able to make overpayments (payments above the required monthly amount). These are usually credited immediately.
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Payment holidays - Once a credit has been built up from overpayments this can be used to take payment holidays.
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Savings accounts - It is possible to take back any overpayment at a later date.
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Banking services - Some lenders give full banking facilities, so a monthly salary can be paid into the account. These are referred to as current account mortgages. A cheque book and credit card would be provided.
Flexible mortgages in the guise of current account mortgages are only suitable for those borrowers who can maintain the discipline of repaying their loan as opposed to treating their account as an open overdraft.
Tracker Mortgage
Is a variable rate mortgage where the interest "tracks" an index, such as the Bank of England base rate. It is designed to move as the base rate moves, usually after a period of around 15 days - although this can vary by lender. All variable rate mortgages are influenced by bank base rate changes but tracker mortgages have an automatic link built in.
Variable Rate
This rate is set by the lender and varies in line with market conditions. Repayments may therefore fluctuate. Any fall in this rate results in lower monthly repayments and an increase will mean high monthly payments.
Most special offer mortgages are 'portable', which means that if you move house, you will still be eligible to benefit from any reduced interest rate on the portion of your loan to the new property at the same interest rate.
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