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Mortgage Advice

Types of mortgages

There are so many mortgages on the market - and it pays to Office around for the best deals.

Look out for the fees that you will be charged by the bank for setting up the mortgage, and any early redemption charges payable if you repay your mortgage before the end of the term, or before the end of any special offer period.

There are four main types of mortgage available:

  1. Fixed Rate: These fix your interest rates for the first 2-5 years, however once this time period expires, your monthly payments return to your lenders standard variable rate (SVR). This means you can budget accurately without having to worry about a sudden increase in your monthly payments.

  2. Variable Rate: The repayments fluctuate with the lenders SVR, which often results in you paying more than you would with other mortgage types.

  3. Capped Rate: This allows you to know the maximum amount you will have to pay, and payments will fall if the interest rate drops.

  4. Discounted rate: These have a fixed time over which the rates will be reduced, which helps keep costs low in the early years of the loan.

Redemption penalties:╩Fixed, variable and discounted rate mortgages╩often have penalties if you stop the mortgage halfway through repayments. These could be a whole six month's interest payments. Always ask about redemption payments when getting a mortgage and read all the small print.

There are three main ways of repaying your mortgage:

Repayment mortgage

The most popular method, this is where you repay your mortgage over a set period of time (normally 25 years). For the first few years of the mortgage most of your monthly repayment is the interest on the loan and only a small amount is repaying any capital. After some time, depending on how much you pay each month, you repay more and more capital, and less interest. You are guaranteed to pay off the mortgage, assuming that you make all the payments on time.

Interest-only mortgages

Here the borrower only repays the interest on the loan each month, which means the debt doesn't ever reduce. The borrower also takes out a saving scheme of some sort that builds up a lump sum to eventually pay back the debt. There are three main types of saving scheme:

  • Endowment Policy: You pay cash into an endowment policy, obtained from an Insurance company or independent financial advisor (IFA), throughout the mortgage term.

  • ISA Mortgage: An Individual Savings Account that can be sorted out through banks, building societies, insurance companies or from and IFA. In this case the savings money is paid into an ISA and that money is then invested on the borrower's behalf.

  • Pension mortgage: Here the savings scheme is a personal pension and thus untaxed. Like the ISA these can be obtained from banks, building societies, insurance companies or from an IFA. The money paid into the pension will be invested on the borrower's behalf to eventually pay back the debt.

You can also have an interest only mortgage without a savings plan however this is rare and you need to prove you are expecting a lump sum of cash to repay the bulk debt such as an inheritance.

New mortgages

As if all the above choices weren't enough, there are also newer kinds of mortgages that have recently been introduced, such as flexible, current account and offset. Many of them claim to save you lots of money over the lifetime of the loan.

Repaying the capital

The two basic choice are repayment and interest-only, although you can have a mixture of the two.

With a repayment mortgage you make one monthly payment. Part of this goes to pay off the interest on your mortgage. The remainder pays off part of the capital. The idea is that at the end of the 25 years (or however long you choose to repay your mortgage over) all your capital has been repaid.

With an interest only mortgage you make two payments each month. One of these is the interest on the capital that you owe. The second goes into an investment of some type (it could be an endowment plan or an ISA for example). The idea is that your investment grows over the 25 years and you use it to repay your capital in one big chunk at the end.

The second is obviously the more risky of the two approaches, as you need to monitor your investments and there is no guarantee that it will cover all of your capital at the end of the term of your mortgage, meaning you would need to find extra money from elsewhere.

Choose how interest is charged

Mortgage interest rates typically vary in line with the base rate set at the beginning of each month by the Bank of England. Typically mortgage rates are 1% to 2% higher than the base rate. If you choose a variable rate mortgage your monthly payment will move up and down depending on what happens to the base rate.

You can often get a discounted rate for a few years at the start of mortgage, although this is usually offset by higher rates later on. Alternatively you can choose a fixed rate mortgage for a number of years. This means your monthly payment won't alter within a set period. Some lenders offer a capped rate meaning that although the rate may vary it is guaranteed not to go above a certain amount.

How mortgage lenders charge their interest can make a big difference. Some calculate the interest due based upon the amount outstanding at the beginning of the year. So if you repaid part of the capital early on in the year if could be up to twelve months before you get the benefit of this in terms of lower interest payments. "New mortgages" operate differently. Here the interest is calculated daily. So you get the benefits of lower interest as soon as you make any repayments.

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