Mortgages
There are a large number of different mortgage options on the market - all suited to different lifestyles and circumstances. It can be confusing understanding all the features of the different products and knowing which one to choose.
You can choose the type of mortgage you'd like - Discount mortgages, Capped, Fixed Rate, Tracker, Cash Back, Flexible/CAM, 100% , First Time Buyer, Self Certification, Buy To Let or Low SetUp Cost. Or if you're wondering which type of mortgage might best suit you, try our What mortgage suits me calculator.
When choosing a mortgage you need to decide:
- Do you want a repayment or interest only mortgage?
- What type of interest rate calculation do you want?
- What other special features suit you?
- If you're looking at an interest only mortgage - what type of repayment vehicle suits you?
Just click the links below for more information:
Repayment or interest only?
Interest rate options
Other features
Repayment methods
Some help in finding the right mortgage for you:
Repayment or interest only?
The key decision you have to make is between a repayment or interest only mortgage - you are either paying only the interest on the money you have borrowed, or both the interest and a portion of the capital.
- Repayment mortgages
With a repayment mortgage your monthly repayments cover both capital and interest on the loan. No other repayment vehicle is needed, but your lender may insist on life insurance in case you die before the mortgage is cleared.
On the plus side, a repayment mortgage is simple, straightforward and easy to understand. It also avoids the risk of investing in the stock market for your repayment vehicle.
However, unlike a pension, ISA or endowment mortgage, repayment loans do not give you the opportunity to benefit from a rising stock market. Also, when remortgaging, people often choose another 25 year repayment mortgage, to keep the initial monthly costs down. This means that the overall total period of your mortgage debts combined increases over time.
- Interest only mortgages
With an interest only mortgage, your monthly payments to the lender cover only the interest on the loan (i.e., they don't repay any of the capital). The full amount of the loan has to be repaid to the lender at the end of the term.
To ensure you can make this final payment, you invest additional funds in investments which are designed to generate enough (preferably more than enough) capital to repay the loan at the end of the term.
On the plus side, you can choose from a variety of investment vehicles, some of which can have tax advantages. And should you move or remortgage, your investment vehicle can usually be reallocated to the new mortgage.
However, unlike a repayment mortgage, the total amount of your debt does not reduce over time. And there is no guarantee that your chosen investment vehicle will grow sufficiently to repay your loan (although you can usually top up your contributions to investments as you go along if this looks likely to be the case).
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Interest rate options
Once you've decided on whether you are going to make payments on the capital or not, you need to turn your mind to interest rate options. There are many different ways of calculating the interest due - all of which have their advantages and disadvantages, depending on your circumstances. Add to this a number of other special types of mortgages - and you have a lot to choose from.
- Standard variable rate(SVR)
The simplest form of loan is one which sets its interest rate according to the lender's standard variable rate, or SVR. With a loan like this, your interest payments are likely to rise or fall every time there is a change in the Bank of England's base rate. However, lenders don't always pass on the change in Base Rate - this can be both to your disadvantage if the rate falls but your interest rate doesn't.
Most borrowers are transferred to their lender's SVR once their initial, promotional rate period comes to an end.
Pros
There are usually no early repayment charges on these loans.
Cons
The unpredictability of interest rate movements makes it hard to plan your finances, and the costs of your mortgage may rise rapidly if interest rates go up.
- Discount rate
A discount mortgage offers a reduction ("discount") of a given amount on the lender's standard variable rate. If the SVR changes, the rate you pay will fluctuate in line with the change but at the same level of discount (e.g. 0.5% below SVR).
Usually, the greater the discount is the shorter the period of discount will be. After the discount finishes, the loan reverts in most cases to the lender's SVR.
Pros
You can make a significant saving on the standard variable rate.
Cons
Discount mortgages often incorporate significant early repayment charges which may make it expensive for you to remortgage to another rate or lender.
- Fixed rate
A fixed rate loan charges a set rate of interest for a predetermined period, and then usually reverts to the lender's standard variable rate. The fixed rate will often be very competitive, however when you revert to the lender's standard variable rate you'll find that this is much higher.
Pros
A fixed rate loan offers you the security of knowing how much you'll be repaying during the initial period which can make budgeting much easier.
Cons
If the Bank Base Rate is dropping, your fixed rate may actually prove to be more expensive than a discount or tracker rate. E.g. you may tie in to a fixed rate which is the "best ever" but the market may continue to drop, leaving you on a higher rate but unable to move due to early repayment charges.
An example of a fixed rate (as at February 2005):
4.85% fixed until 28 February 2007, then reverting to the lenders standard variable rate at that time. Early Repayment Charges apply if you remortgage early.
- Capped
A capped rate will not rise above a certain level for the cap period - offering similar security to the fixed rate. You can have confidence that your interest rate will not exceed the cap, whatever happens to the lender's standard variable rate. The initial rate is usually competitive, however the deal will often also incorporate early repayment charges.
Pros
A capped rate offers you the security of knowing how much you'll be repaying during the initial rate period, which can make budgeting much easier.
Cons
As a payback for the security of the capped rate, rates are often higher than a fixed rate and the initial cap term seldom lasts longer than 2 or 3 years.
An example of a capped rate (as at February 2005):
4.75% capped until 31 March 2010, then reverting to the lenders standard variable rate at that time. Early Repayment Charges apply if you remortgage early.
- Tracker
A tracker rate gives you the certainty of knowing the rate you pay will move automatically in line with Bank Base Rates. You benefit straight away from any reduction in Bank Base Rate, even if the lender delays reducing its standard variable rate to reflect the reduction.
Tracker rates often track Bank Base Rate by a certain percentage, e.g. Bank Base plus 0.75% for the full term of the mortgage.
Many tracker products also offer flexible terms.
Pros
A tracker rate means that you immediately benefit from any reduction in Bank Base Rate - which is particularly beneficial in times of low Base Rates.
Cons
If Bank Base Rate increases your interest rate will also move up, will those on capped or fixed rates keep their low rate for longer.
An example of a tracker rate (as at February 2005):
Base Rate plus 0.19% for the term of the mortgage.
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Other features
As well as having one of the above interest rate features, mortgages often offer a number of other options, which can help you make the decision on what is best for you and your circumstances.
- Flexible mortgages
A flexible mortgage allows you to vary your monthly repayments. Depending on the flexibility of the particular mortgage, you can, without charge:
- Make over or underpayments each month (e.g. you know you will have high expenses in June, so choose to underpay that month).
- Make a lump sum repayment (e.g. if you receive a bonus and decide to put it all into the mortgage).
- Take a payment 'holiday' (you might want to pay for a car or a holiday and need to take a break from your mortgage payments for a while).
The flexibility is conditional - usually you have to follow (or exceed) a predetermined repayment schedule.
TOP TIP: Look out for a mortgage which may not officially be "flexible" but still allows the ability to make overpayments.
- Cashback mortgages
A cashback mortgage pays out an upfront lump sum when the mortgage is taken out. This sum can then by used to pay, for example, for home furnishings or pay off a credit card debt.
If you do take out a cashback mortgage you will often find that the interest rate is the lender's standard variable rate - the disadvantage of the cashback is the lack of flexibility or competitiveness on the interest rate.
- Droplock mortgages
A droplock mortgage is a discount or tracker mortgage which has an option to switch to a fixed rate at any point within the initial discount or tracker period without paying any early repayment charges.
This provides an ideal way to benefit from base rates when they're low, with the option to switch easily to the protection of a fixed rate should interest rates look set to rise significantly.
- Current account mortgages
Current account mortgages combine a mortgage and a current (banking & cheque) account. They're designed to fit into the "modern lifestyle" and can be ideal if you would like the option to make overpayments on your mortgage (e.g. if you are self-employed or receive irregular bonus payments).
The other advantage is that interest is calculated on a daily basis, so when you pay money into your account the overall loan size is lowered, thereby reducing the total amount of interest paid.
It's easiest to think of a current account mortgage as a large overdraft - when you have your salary paid into your account each month the overdraft is reduced and therefore so is the interest. Even when you make withdrawals from your account over the month, because the total overdraft has been reduced, the interest accrued is lower and the time to paying off your mortgage is reduced.
To see how a current account mortgage could save you money over time just click here to use our calculator.
- Offset mortgages
Like current account mortgages, offset products allow you to offset the balance of your mortgage against any funds in a savings and/or current account held with the same lender, and pay interest (calculated on a daily basis) on the net balance between the accounts.
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Repayment methods
If you choose an interest only mortgage you will also need to arrange a repayment method to pay back the capital at the end of the mortgage. There are a number of different options available, including an endowment or a pension or an ISA.
- Endowment
With an endowment mortgage you make your monthly repayments of interest to the lender and as well as this you make contributions to an insurance company to fund a savings plan. This savings plan aims to generate sufficient funds to pay off the capital at the end of your agreed mortgage term.
The savings plan can be "with profits", "unit-linked" or a combination of them both.
"With profits" policies pays two types of bonuses. A "reversionary" bonus is usually paid into the savings plan each year and, once awarded, is usually guaranteed provided the policy is still active on the maturity date. A "terminal" bonus is awarded on the policy maturity date and its size will depend on the performance of the fund over the lifetime of the policy.
With "unit-linked policies", the value is driven by the underlying value of the investments when the policy reaches maturity (but you can often swap into safer investments a few years earlier if you wish). If you die before the term is complete, the life insurance aspect of the endowment policy is used to clear the loan.
The good thing about an endowment repayment vehicle is that you can maintain the policy if you move house or change mortgage provider. Endowments can include some kind of life and critical illness cover which is usually cheaper than buying such cover separately. If the underlying investments perform well, you may get more than is needed to pay off the loan.
But if the underlying investment performs poorly, you could end up having to review the premium subscriptions to your endowment policy and/or the basis on which your mortgage is operated in order to ensure that the mortgage loan can still be repaid in full at the end of the agreed term.
- Pension
With a pension repayment vehicle, you make your monthly repayments of interest to the lender and you also make contributions to a personal pension. This personal pension then provides a tax-free lump sum as well as a taxed regular income at retirement. Most, if not all, of the lump sum is used to clear your mortgage loan at that date.
On the good side, pension contributions qualify for tax relief of up to 40% (for a higher rate taxpayer), which boosts the value of every pound you contribute to your pension.
However, using your tax-free lump sum as a mortgage repayment vehicle may leave you with inadequate income in retirement. Also, the lump sum is payable on retirement, so your loan term may be more than 25 years (depending on how old you are and when you are planning to retire!). The biggest problem is that poor performance could adversely affect the amount of the tax-free lump sum resulting in insufficient funds available to repay the loan at the end of the agreed term.
- ISA
With a pension repayment vehicle, you make your monthly repayments of interest to the lender and you also make contributions to an Individual Savings Account (ISA). Like the PEP mortgages which preceded them, ISA mortgages use stock market-based investments for tax-free growth.
There are two main types of ISA: "mini" and "maxi". There are different rules over contribution levels and range of investments available in each. If you take an ISA as a repayment vehicle you are also likely to be required by the lender to take out term assurance to cover repayment of the loan if you die early.
On the plus side, if your ISA performs well, you may be able to pay off your mortgage early.
However, a stock market crash could leave your investment in trouble. Also, current tax rules dictate that the maximum investment in an ISA is £7,000 per annum, which won't be enough to give you confidence that you will be able to repay a large mortgage at the end of the term.
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Some help in finding the right mortgage for you:
Search for our Best Buy Mortgages (including discount, tracker, fixed and more).
Search for the right mortgage for you.
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Your home may be repossessed if you do not keep up repayments on your mortgage
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Charcolonline is a trading name of @Charcol Limited. Registered office: Holbrook House, 10-12 Great Queen Street, London, WC2B 5DD. Registered in England No: 3795361.
@Charcol Limited is an appointed representative of Charcol Limited which is authorised and regulated by the Financial Services Authority (FSA reg. 427339). Registered Office: Holbrook House, 10-12 Great Queen Street, London, WC2B 5DD. Registered in England No: 3397767. The FSA does not regulate some investment mortgage contracts, these are regulated by the Consumer Credit Act (CCA).
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