Mortgage Types

What mortgage types are there and what are the differences

Overwhelmed by the number of different mortgages available?

Taking out a mortgage should be fairly straightforward. You take out a loan to buy a property and you pay interest on the loan. Simple.

 

You then look at what is available and start to feel rather overwhelmed by the sheer number of different mortgages. Banks are constantly updating their range of mortgages and it all becomes very confusing.

 

Mortgage Fox has compiled a comprehensive list of mortgages types. The two main types of mortgages are Repayment mortgages and Interest only mortgages.

 

 

Repayment mortgages

Each month you repay some of the capital amount borrowed plus some of the interest on the loan.

 

This is considered to be the easiest to understand and the least risky of all the mortgage types. You may be able to make lump sum payments or pay slightly more if you wish to reduce both the capital and the interest before the end of the loan term, although you will probably have to pay a fee for this.

 

During the first few years of the mortgage you will pay more off the interest than the mortgage loan. This is only a disadvantage if you move house regularly. You may not need to take out Life Insurance with a Repayment Mortgage but it is advisable because if you die before the mortgage is repaid the loan still has to be paid off.

 

 

Interest Only Mortgage

With this type of mortgage your monthly payment only pays off the interest.

 

None of the original loan is paid off. The idea is that the borrower takes out a savings scheme to pay off the loan at the end off the term. Your mortgage repayments are less but it is really important that money is put to one side to pay off the loan.

 

Interest only loans are popular with first time buyers and buy to let investors.

 

It is important to discuss this type of mortgage with an expert.

 

 

Fixed Rate Mortgages

This mortgage type is just as it sounds. The rate is fixed for a set period. If you take out two or a five year deal at 3% it doesn’t matter what happens with the mortgage rate your repayments stay at that rate for the set period.

 

The rate is usually fixed for two, three or five years, although it can be for longer if required. However a deal with a longer fixed rate may not be to your advantage if the mortgage rate goes down.

 

At the end of the fixed term your rate will be converted to the standard variable rate.

First time buyers usually favour this type of mortgage.

 

It is important to remember that there will be a hefty charge if you change to a different type of mortgage or re-pay the mortgage before the end of the fixed term. The charge could amount to several thousand pounds.

 

 

Flexible Mortgages

Some mortgage lenders will offer Flexible mortgages although terms and benefits will vary quite a lot.

 

You are able to vary your monthly repayments with this type of mortgage. You can pay more or less than your normal monthly payment or even nothing at all. This will not happen initially as you need to build up money in your mortgage 'account'. If you find that you have overpaid your mortgage by quite a large amount you can then take a mortgage holiday or miss a payment. If your salary fluctuates or you have a bonus you can pay off a lump sum.

 

Most Flexible mortgages have interest calculated on a daily or monthly basis so your mortgage reduces quicker and you save money.

This type of mortgage is ideal for the self-employed or anyone whose salary fluctuates.

 

 

Buy to Let Mortgage

There is currently a whole range of buy to let mortgages, ranging from fixed rate and trackers to discounts and flexible rate mortgages. In the past variable rate mortgages were the only types available to property investors.

 

The amount you can borrow is often based on the rental income rather than your salary. Some banks are happy to offer you several buy to let mortgages so that you can build up a property portfolio.The interest rate will be slightly higher on this type of mortgage and often a higher deposit is required.

 

Your rental income should cover the cost of your mortgage.

Lenders will typically give you a maximum of 75% of the property value for buy to let.

 

Most buy to let investors opt for an interest only mortgage. The capital is repaid when the property is sold.

 

 

Capped Rate Mortgages

Capped rate deals are more expensive than fixed rate mortgages and there are fewer around.
A maximum interest rate is agreed for a set period of time. This is the cap.

 

If the standard variable rate of interest (SVR) goes down your interest rate will go down with it. You can take advantage of the low rates but your mortgage rate will not rise above your cap.
Some capped mortgages also have a floor. This is known as a cap and collar loan.

 

This type of deal is usually taken out over three, five or ten years.

 

 

Variable Rate Mortgage

All lenders have a standard variable rate (SVR) which is linked to market conditions. So your mortgage re-payments will go up or down according to the Bank of England interest rate. Basically if the interest rate goes up so will your mortgage re-payments. If the interest rate falls your payments will follow suit and you will save money .It is easy to budget with this type of mortgage.
Most people change to variable rate mortgage when their fixed rate deal ends.

 

 

ISA Mortgages

The ISA ( Individual Savings Account) is a tax-free method of saving. It replaced PEP’s and TESSA’s in 1999.

 

There are three types of ISA’s- Cash, Insurance and stocks and shares. When ISA’s are used for mortgage purposes, equity (linked to the stock-market) ISA's are taken out. You will invest a monthly sum through a specialist ISA mortgage package or as part of a personal portfolio of ISA investments. The money invested should increase in value tax-free and you may hopefully be able to repay your loan early.

 

With an ISA you don’t have to pay any commission and you are limited to how much you can invest each year.

 

ISA mortgages are less popular than they used to be and some lenders no longer offer them.
Please remember that ISA’s are linked to the stock market and you should take advise from a qualified financial advisor.

 

 

Endowment Mortgage

Endowment mortgages were very popular in the 1980’s due to the stock market being at a high. 80% of mortgages were Endowment mortgages but by 2001 this had fallen to 10% as shares fell.
Insurance companies had to inform many endowment holders that their policies would not cover their mortgage loans. This caused a huge scandal about the miss selling of endowment policies.
An endowment mortgage is a type of interest only mortgage, which also provides life insurance cover. Your payments are based on the amount of your loan. Your money is invested and should at the end of your mortgage term provide sufficient cash to pay off your mortgage.

 

There are two types of endowment polices- 'with profits' and 'unit linked'.

 

With- profits endowments.

Your monthly payments are pooled with those of other investors. The insurer will pay out bonuses at the end of the year depending on the performance of the investments. At the end of your mortgage term you will get a one off terminal bonus, which may pay off your mortgage loan. -You must remember that this is not guaranteed.

 

Unit-linked endowments.

Your payments buy units in stock market linked investments. Your investments will go up and down on a daily basis. This type of endowment can grow quicker than the with-profits endowment but there is a bigger risk involved.

 

Endowment mortgages are covered by life insurance so your mortgage will be paid off in the event of premature death.

 

There is no guarantee that your ‘lump sum’ will be sufficient to pay off your mortgage.

It is a gamble that the stock market will perform and investments can go down.

 

It is important to discuss this type of mortgage with an expert.

 

 

Pension Mortgages

Pension mortgages are only available to the self-employed or to employees who are not in a company pension scheme.

 

Pension mortgages are interest only mortgages.

 

Instead of investing in an ISA or an endowment your extra monthly payments are invested in a personal pension fund. Premiums are also paid into a life insurance scheme. This does mean that you will not pay off your mortgage until you reach retirement age.

 

When you retire you will receive a tax- free lump sum, usually 25 % of your pension pot, which should pay off your mortgage loan. The balance of the money in your fund will be used to purchase an annuity, which will be your pension for the rest of your life.

 

Pension mortgages are risky as they are linked to the stock market.

Pension mortgages are not suitable for everyone and expert advise should be taken.

 

Pension mortgages run for longer than other types of mortgages, maybe up to 35 or 40 years.
Pension are a tax efficient way of saving as for every 78p that a basic rate tax payer invests the Government will top up your contributions to £1. (60p for a higher rate tax payer) this tax relief is not available when investing in an ISA or Endowment mortgage.

 

 

Index Tracker Mortgage

An index tracker mortgage is usually set 1% above the base rate (The Bank of England base rate or The London Interbank Offered Rate) for a set period of time .If the base rate is 4.5% you pay 5.5% until the rate changes. Tracker mortgages follow the track changes in the base rate.
The lender cannot charge you more than the agreed rate so you benefit if the base rate goes down.

 

These tracker deals do not carry any penalties when the deal ends but they can cost you more as they always track above the base rate. Arrangement fees may also be charged.
A fixed or discounted deal may be a better option.

 

 

Discount Rate Mortgage

The lender can offer a discount on the Standard Variable Rate for a set period of time. For example the standard variable rate (SVR) may be 6% and the lender may offer a discount of 2% over 2 years. Your rate initially is 4%, for a 2 year period.

 

The discount is linked to the SVR and changes accordingly. If the rate increases you pay more if it decreases you benefit.

 

Budgeting can be a problem with this type of mortgage.

There is usually an early repayment charge.

Only opt for this type of offer if you can cope with increases in your monthly payments.

 

 

Offset and Current Account Mortgages

Offset and Current Account Mortgages are comparatively new. They are pretty much the same with just a few slight differences.

 

 

Offset Mortgage

This type of mortgage allows you to use your saving to reduce the amount of interest you pay on your mortgage.

 

You open a current account and/or a savings account with your mortgage lender. When you pay your monthly mortgage payment you savings and current account are counted against your mortgage balance and the interest that you are charged will be reduced.

 

If your mortgage is £75,000 and you have £5000. in savings and £800 in your current account you will be charged interest on £69200 instead of £75000.The interest is calculated on a daily basis you should try to leave the cash in your accounts for as long as possible.

 

 

Current Account Mortgage

Current Account Mortgages are similar but your mortgage loan, savings, current account and even your credit cards and other loans are all lumped together into one account. Your monthly statement will show one overall figure, which will usually be a minus. You pay your usual mortgage payment and your savings and the cash in your current account reduce the amount of interest owed.

 

The interest on both these accounts is calculated daily so when you are paid your salary will be offset against your mortgage. Your loan will be repaid quicker.

 

If you are a first time buyer with few savings this may not be the best option as these mortgages tend to be more expensive and a fixed rate mortgage may be the best option for you.

 

 

Lifetime Mortgage

A Lifetime Mortgage is a special loan for homeowners who are over 60 years of age.

 

The loan is secured on your property and there are no monthly payments to be made. The loan allows the homeowner to benefit from the financial investment that you have made in your home. You do not have to give up your home and you live there for as long as you wish.

 

However interest is added to your loan which has to be repaid when you house is sold. Either after your death or if you have to move into care.

 

This sort of commitment should be discussed with an Independent Financial Advisor.

 

 

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