Mortgage Types Explained

There are many different types of Mortgages available and it can be a minefield to decide what is the best type of Mortgage for your particular circumstances. Below I have listed and explained what each different type of Mortgage is what the pros and cons of them are.

Firstly lets look at the different types of repayment options there are:-

  1. Capital and Interest repayments. - This is the standard way of paying off your Mortgage. Each month you make a payment an element fo this payment will be Interest and an element will repayment of the capital. In the early years the Interest element is larger than the repayment of capital element. As time goes by the Interest element gets smaller and the Capital repayment element gets bigger therefore reducing the outstanding amount to repay.
    1. Pros - by using this method you will pay off the outsanding Balance by the end of the term
    2. Cons - this is more expensive than an Interest only Mortgage
  2. Interest only. This is where you borrow the money over a fixe term and all you are paying every month is the Interest on the outsanding Loan. At the end of the term you will still owe the original amount of the Loan. Therefore you will need a repayment vechilcle to pay off the outstanding balance
    1. Pros - This is a cheaper option than a Repayment Mortgage and can make a purchase affordable in the early years. Also this is uesful for Investors who plan on letting the property out as all the Interest payments can be offset against Tax. Most property investors use this method as they are looking for capital growth whilst the tenant is paying rent which funds the Mortgage
    2. Cons - you are not paying the outstanding balance off only the Interest. Therefore you will need some form of repayment vehicle to pay off the outstanding balance at the end of the term or you will have to sell the property to repay the balance.
  3. Part and Part - This is a combination of the two above.
    1. Pros - Using this method can make a property more affordabale in the early years and you are still paying off some of the Capital.
    2. Cons - You are not paying off as much capital as a repayment Mortgage and you will still have to fund the outstanding balance at the end of the term of the Mortgage.

So thats th main types of repayment methods now we will look at the different types of Interest rates that are available.

  1. The most basic type of Interest rate is the Standard variable rate.(SVR) This is the rate set by the lender and is open to change either up or down as they see fit.
    1. Pros - Generally there are very low fees for this type of rate and there are no redemption fees so if you need to move or sell the property within the Mortgage term you will not have to pay a penalty.
    2. Cons - The rate can be more expensive than other types and you are open to market fluctuations so plan for being able to afford any increases in rates. 
  2. Capped rates - these are less common then they used to be. Basically the lender will set a capped rate which means that the rate will never go above this rate even if interest rates go much higher than your capped rate. If rates fall below your capped rate you will also benefit form this fall in rates.
    1. Pros - This type ensures that you always know what your maximum payments will ever be and you will benefit form drops below your capped rate.
    2. Cons - Large upfront fees that they will add to the Loan and normally a redemption fee set as a percentage of the outstanding balance during the period of the capped rate. Less flexible than a Standard Variable rate.
  3. Discount rate - this is a rate calculated in one of two ways, either a discount on the lenders own variable rate or a discount rate on the Bank of England base rate (rare now).
    1. Pros - can be a lot cheaper than a standard variable rate.
    2. Cons - large upfront fees added to the Loan. Redemption penalties if you want to get out of the loan during the agreed discount period. Your monthly payments will go up and down in line with Interest rates so be prepared for increases if rates go up.
  4. Tracker rates - these are rates that are tied to either the Bank of England base rates or the LIBOR Rate with an additional margin. I.e. Bank of England base rate %u01AE.75% so if the BER was 5% you would be paying 5.75%.
    1. Pros - can be cheaper than SVR rates and have lower fees.
    2. Cons - Open to market fluctuations so payments can go up and down. Also may have a redemption fee.
  5. Fixed Rates - these do what they say on the tin. You fix a rate for an agreed period of time, usually 2,3,5,7 or 10 years. This is a good way to make sure you have peace of mind for the period fix it as you know it will not go upo or down.
    1. Pros - Fixed monthly payments so you can budget. Rate will not change with any market fluctuations.
    2. Cons - large upfront fees added to the Loan and always a redemption fee. can be inflexible if you want to move or sell up. 

 Just a quick word on how Interest is Calculated.

  1. Daily - this is by far the best method and always ask for this. This means that every time you make a payment the Interest is recalculated on a daily basis. This is the cheapest.
  2. Monthly - this is where they calculate the interest monthly. So if you make a payment on the 3rd of the Month and they calculate the Interest on the 30th of the month, they will have applied your payment 27 days after you made the payment and you will have paid interest on a larger outstanding balance for those 27 days.
  3. Yearly - as above but done on yaerly basis. NEVER EVER go for this type of mortgage as it will cost a lot more over the term of the Mortgage.

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