Selecting the correct mortgage is almost as important as choosing the right property. You should consider your options carefully and do your research to make sure you're getting the best deal for your circumstances.
With so many mortgages to choose from, knowing which one is best for you can be confusing, so get up to speed with our guide to choosing the best mortgage.
Unless you know exactly what you want, you should seek professional advice from a mortgage adviser, but it also pays to get up to speed first on what products are out there when you're buying your home.
Your first consideration should be determining what you can reasonably afford to borrow. Many lenders will have a process of understanding your income and outgoings to make sure you're not overstretching yourself and you should be confident you can handle the repayments comfortably. Remember, interest rates can go up as well as down, so make sure you've got enough flexibility to cover potential increases in your repayments.
Mortgage repayments tend to be one of the largest monthly financial outgoings, so it's always worth shopping around, switching to a better deal if you can, or negotiating with your existing lender to make sure you're getting the best mortgage deal for your money.
There are literally thousands of mortgages available in the marketplace today and choosing the right one can be a complicated process. Here are some of the options available to you, including various mortgage types, repayment options and specialist mortgages for those with more complicated circumstances.
The first aspect of mortgages to consider is how you intend to pay back the money that you've borrowed. In practice, there are two main ways of repaying your mortgage. These are repayment mortgages and interest-only mortgages:
- Repayment mortgages (or 'capital and interest repayment')
With a repayment mortgage, every month you are essentially paying back both the interest and the capital (the amount you borrowed) to the lender. This is a popular mortgage option as it offers the reassurance that at the end of the agreed term, your property will be totally paid off and you will not owe your lender any more money.
The repayment option also means you're not relying on a linked investment vehicle to generate the money required to pay off the capital at the end of the mortgage term. Although you will have the confidence that you're paying your lender back the full amount each month, this option is more expensive than the interest-only option.
- Interest-only mortgages
With an interest-only repayment option, your mortgage payments only cover the repayment of the interest from the amount you borrowed, so although your monthly repayments will be lower, you are not repaying the capital (the amount you borrowed). It is advisable, therefore, that you pay a sufficient sum of money into a separate investment vehicle that will produce the capital at the end of the term to allow you to pay off the mortgage.
With property prices rising so rapidly over the last few years, many buyers have chosen the interest-only option in order to afford to buy their property, but without having a separate repayment option to raise the capital required. This is a risky option and could leave you exposed at a later stage, so you should seek suitable advice before choosing this option.
If you choose to get an interest-only mortgage, you should consider how you intend to pay back the capital you have borrowed and which vehicle is best for you. It is best to seek advice from a mortgage adviser when selecting an appropriate vehicle for generating the capital.
An endowment is an investment vehicle and used to be a very popular means of helping mortgage holders pay off their mortgage. A homeowner would make the interest payment to the mortgage lender each month and pay a separate amount into the endowment. As well as being a means of saving, it also contains a life insurance element to pay off the mortgage, should you die during the term of the mortgage.
Being an investment linked to the stock market, returns can go down as well as up. A large number of homebuyers who were sold endowment policies in the late eighties found that by the end of their mortgage term, there were insufficient funds available to cover the capital repayment, forcing them to find the capital elsewhere. For this reason, endowment mortgages tend to be less popular these days.
ISA mortgages are a smart way of being able to save the capital tax free. Introduced by the government to encourage savers, there are two types available: a Maxi ISA and a Mini ISA, which allow you to save up to £7,000 in any tax year, tax free.
You can either have a single Maxi ISA, or up to two Mini ISAs with different providers. ISAs can be made up of cash or stocks and shares. The Maxi ISA is made up of stocks and shares and is therefore often used as a mortgage repayment vehicle. The additional benefit of using an ISA as a repayment vehicle is that it is flexible and you can stop and start payments whenever you like. However, being an investment, they carry the risk that at the end of the term there might be insufficient funds to pay off the mortgage.
Interest rate options
There are plenty of interest rate options available to the homebuyer when taking out or switching mortgages and this is often the area that causes the most confusion. What you choose will depend largely on your current circumstances, such as whether you a first time buyer, close to the end of your term, or what can you afford. Here are some of the options available:
- Fixed rate mortgages
Fixed rates are one of the most popular interest rate options for consumers, particularly in an environment of rising interest rates. With a fixed rate, you guarantee that your rate and therefore your monthly repayments remain constant every month for a set period of time, whatever the lender does with the standard variable rate, or what base rates do. The length of time the fixed rate can run for varies depending on the mortgage you choose.
The most common fixed rate periods range between one and five years, although there are now 25 year fixed rate mortgages on the market. After the fixed rate period expires, the rate reverts to the lender's standard variable rate, which will fluctuate along with base rates. If interest rates are rising, you remain protected against them. But should they fall, you'll miss out on any potential reduction in your repayments.
Be careful, as many lenders will charge you a penalty if you move your mortgage before the fixed term ends. Be sure to shop around for the best deal for you and make sure you read the small print.
- Discounted rate mortgages
With a discounted mortgage rate, you pay a set amount below the lender's standard variable rate for a fixed period of time. For example, if the lender's standard variable rate is seven per cent and you choose a two per cent discount, the interest rate you will pay will be five per cent for the agreed term. The terms can range between six months and five years.
Generally speaking, if the term is short, the discount is likely to be greater, while for longer terms the discount is likely to be smaller. These mortgages are particularly helpful if you want to reduce your monthly payments at the outset and are comfortable that you will be able to afford the payments after the discounted period.
In some cases the discount can be 'stepped', which means the rate reduces in two or three stages.
- Capped rate mortgages
A capped rate mortgage is like combining a fixed rate with a variable rate. For example, for a defined period of time, your interest rate is guaranteed not to rise above an agreed fixed rate, but you should retain the benefits of smaller repayments should the interest rate go down. The terms can range from between a few months to the duration of the mortgage in some cases. Capped rates tend be more popular in a rising interest rate environment.
However, capped rate mortgages tend to be more expensive than fixed rate mortgages. As with discounted and fixed rate mortgages, you may incur a charge if you move your mortgage before the end of the agreed period of the offer.
- Variable rate mortgages
This is essentially the lender's standard variable rate. It will be higher than any introductory interest rate and your repayments will generally go up or down with base rate changes. Most borrowers will find themselves better off with an alternative special interest rate option, particularly if you switch when introductory offers come to an end. Be aware of any charges that might be incurred for switching mortgages before taking any action.
- Tracker rate mortgages
Tracker rates are relatively new mortgage options whereby the interest rate you pay is guaranteed to stay at a certain level above the base rate. The rate will then remain within that set level above the base rate, whether it goes up or down, usually for the term of the mortgage. For example, you might find a deal whereby you pay one per cent above the base rate, whatever it may be or change to. Although you pay more of the base rate rises, you will benefit from any reductions in the base rate over the term.
Other options to consider
As well as interest rates and repayment vehicles, there are a few other options worth considering when choosing a mortgage.
You may also qualify for a better deal depending on how much of a deposit you can put forward. Sometimes, interest rates are lower on an 80 per cent mortgage compared to a 100 per cent mortgage. Buying a property can be a very expensive task, but when you apply it's worth asking your mortgage adviser, or lender, to set up different scenarios to allow you to pick the best one for you. For example, if you have chosen a mortgage that requires a 15 per cent deposit, see what the repayments would be if you decided to pay a 16 per cent deposit.
Originating from Australia, many mortgages now contain flexible features. In essence, they provide you with the ability to overpay or underpay each month. This is valuable if you get regular bonuses, or if your income fluctuates. Interest is often calculated on a daily basis, meaning that overpaying has an instant effect on reducing the balance, and therefore the term, of your mortgage.
Usually, in order to make an 'underpayment', or payment holiday, you will be required to have built up an equivalent amount of credit through overpayments first.
Current account mortgages
A current account mortgage allows you to use your mortgage through your current account. Effectively, your current account becomes a huge overdraft. For example, if your mortgage was £100,000 and you have £5,000 of credit in current account, your balance will be -£95,000. By paying in your salary and/or savings, the interest you earn will go towards cancelling out some of the interest you owe on your mortgage. If you're disciplined, you can eventually repay your mortgage more quickly.
This is a similar concept to a current account mortgage, but the accounts remain separate and all balances are offset against each other. That means that whatever credit balances you have in savings and in your current account will be used to offset the equivalent value owed on your mortgage, reducing interest repayments in the long term. Most offset mortgages are variable rate, meaning the rate can increase or decrease.
Mortgage payment protection
Having a mortgage is a big commitment. You should consider the implications of not being able to meet the repayments, through unemployment, accident, sickness or even death. Many borrowers take out a payment protection policy to protect both themselves and their loved ones should the unthinkable happen.
Every one of us is different and so are our circumstances. That's why there are a range of specialist mortgages available to borrowers who may have encountered previous credit problems, or who may be thinking about venturing into buy to let, or who are buying a very high value property.
If you're already in a position to start thinking about funding your investment, then a buy-to-let mortgage should be where to start. There are many buy-to-let mortgage products out there to serve an ever expanding market, including capital and interest repayments and interest-only. But the distinction between a standard mortgage and one for this purpose is around the criteria upon which a lender will fund the purchase.
Lenders will require a much larger deposit for a buy-to-let mortgage than a standard one and will often want to check that your rental income will bring in much more than the proposed mortgage repayment. If you're looking to buy to let, get up to speed on everything you need to know by reading our guide on how to buy to let.
Adverse credit mortgages
A so-called adverse credit history could be due to missed payments in the past, County Court Judgements or bankruptcy. The good news is that there are plenty of lenders out there who may be willing to lend money to purchase a property in the event of such circumstances. Adverse credit mortgages tend to be sold primarily through brokers and this should be your first port of call. Make sure they are regulated by the Mortgage Code before you start dealing with them.
You will most likely find that mortgage deals for those with adverse credit will be much more expensive than standard mortgages in order to compensate for the increased risk to the lender. The premium has increased since the credit crunch in the summer of 2007. In some cases, however, lenders will reduce the rate if you successfully make a large number of consecutive repayments without any problems. After three years of making repayments, you may be able to switch to a standard loan.
For those who have problems verifying their income, or whose income is irregular (like the self-employed), there are lenders who will consider granting mortgages under these circumstances. You will need to understand your income, but you will not be expected to prove your total earnings. Other terms will depend on your lender and what the market rates are at the time. Remember, though, it is a criminal offence to lie about your income.
Some of the more affluent buyers will undoubtedly be, and are, cash buyers, giving them an edge over the competition. But many are also opting for a mortgage, allowing them to free up valuable capital best served for other investments or ventures. Like the prime property market, the high value mortgage market is very different from the mainstream.
Many high street lenders have an upper limit on mortgages lent to individuals, with often the most competitive mortgage offers restricted to mortgages well under £500,000. Higher property prices across the country have forced a rethink among mainstream lenders, with some raising these limits, but many will charge a premium for the privilege, either through higher interest rates or inflated arrangement fees. Many super rich purchasers turn to a specialist broker to help them secure the best prime mortgage deal.
A broker with the right contacts can negotiate the best rate on six, seven or eight figure loans. Many lenders baulk at lending more than £500,000, while those that do tend to charge a premium on the rate, as more sophisticated brokers are more likely to churn, or move onto a better deal once the offer period ends.
But the right broker can negotiate discounts off the lender's standard mortgage offering. This ensures the client gets the same terms the lender would offer on smaller mortgages, which can save thousands of pounds a year.
Some information contained herein may have changed since it was first published. PrimeLocation strongly advises you to seek current legal and/or financial advise from a qualified professional.