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If you want to buy a new home then it's time to think about mortgages. A mortgage is a sum of money borrowed from a bank or building society so you can purchase a property. The money is then paid back to the Lender over a fixed period of time together with the accrued interest. There are many different types of mortgages and there will be one out there that best suits you, finding the right one can be a daunting task with so many to choose from.

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Different types of mortgage

Deciding on a mortgage does not have to be an overwhelming experience; there are many types of mortgage available with different sets of benefits suiting individual circumstances. Generally you can only borrow up to 95% of the property value. You can get 100% mortgages, but high interest rates make them expensive. You could end up paying 1% more to borrow at this level, it would be more prudent to save a larger deposit. Lenders usually give better deals to people with larger deposits, so it could be worth raiding your savings to get one. The majority of homebuyers decide to repay their mortgages over 25 years. If, for instance, you are an older buyer you may decide to repay your mortgage over a shorter period.

What is a mortgage?

Kinds of Mortgage - There are essentially two different types of mortgage:

Repayment only - (capital and interest mortgage)
Interest only - (ISA, pension or endowment mortgage)

Repayment Mortgages - Monthly repayments consist of repaying the capital amount borrowed as well as the accrued interest. Your mortgage statement, usually received annually, shows the amount borrowed decreases throughout the term. The big advantage of a repayment mortgage is that at the end of the term, you can be sure that the total amount of the debt has been repaid.

Interest Only Mortgages - Only the interest is actually paid off with each mortgage payment. The borrower also takes out at the same time, an alternative 'repayment vehicle' (method of paying off the mortgage) such as an ISA, pension plan or an endowment policy. The monthly repayments do not repay any of the outstanding capital balance. So it is important that the repayment vehicle payments are maintained, otherwise it will not be possible to pay off the mortgage at the end of the term.

Endowment Policies - This is the most common type of interest only mortgage which also provides life assurance cover and a fixed payment for investment. The fixed payments are based on the amount of the loan together with the mortgage term and are designed so that, at maturity, the amount invested and earnings are enough to pay off the mortgage. However - there is no guarantee that, when the endowment matures and 'pays out', the balance will be sufficient to repay the mortgage, the funds success depends on the interest rates.

ISA - The Individual Savings Account (ISA) is a tax free way of saving. Using an ISA as a repayment vehicle has increased in popularity, however due to the ISAs complexity, it is only for the financially sophisticated or borrowers taking advice from a qualified financial adviser.

Pension Plan - Life assurance cover is provided and the monthly payments are then made into a pension fund. When the benefits are eventually taken, the mortgage is repaid using tax-free cash from the remainder of the fund.

Mortgage Interest Rates

Once you have chosen the right mortgage for you, whether it is a repayment or an interest only mortgage, you will need to consider the 4 main mortgage rate options available.

Fixed Rate - The amount you repay the lender each month can be at a fixed interest rate for a certain period of time. Usually lenders offer rates fixed for a period of 2 to 5 years, but shorter and longer periods can be found in the market. At the end of the fixed rate (or 'benefit') term the rate will convert to the lenders Standard Variable Rate (SVR).

Capped Rate - A capped rate mortgage is similar to a fixed, except that if the variable rate falls below the capped rate, the borrower will make payments based on the lower variable rate. But if the rates increase the payments will be 'capped' and will not rise over the capped rate. A capped rate is better to have than a fixed if all other factors are equal.

Discounted Rate Mortgages - The Lender offers a discount on the Standard Variable Rate (SVR) for a precise period of time. E.g. the variable rate may be 5% with a discount of 1.5%. The initial pay rate would therefore be 3.5%. If the variable rate rose to 6%, then the rate payable would rise to 4.5%. As the discount is linked to the standard variable rate, the borrowers payments will increase, if rates rise - so there is no certainty in budgeting. Should rates decrease the borrower will benefit from lower payments.

Variable Rate Mortgages - Borrowers pay the Standard Variable Rate, their payments increase or decrease as the lender adjusts the rate in accordance with market conditions.

SMART Quotes Loans Guide provides background information only and accepts no responsibility
or liability for any loss or damage incurred as a result of relying on information contained on this website.

If you have a specific problem you are advised to consult an appropriately qualified professional.

Security over property may be required. Your home is at risk if you do not keep up repayments on a mortgage or other loan secured on it.