Tue 14 Apr 2009
A mortgage is a loan from a bank or building society that, because it is so large, is secured against the property you are using it to buy. This means that if you default on your monthly repayments the lender can take your home away from you.
Usually a mortgage is repayable over 25 years, although you can organise a longer or shorter-term deal, or even vary the length of the repayment schedule as you progress. You also numerous choices in paying your loan back.
Mortgage type and interest rate
Most lenders offer a range of different mortgages with varying interest rates. Some of these will be based on the lender's standard variable rate (SVR) - a rate above the Bank of England base rate, which the lender can change at any time.
Rather than choosing an SVR mortgage, you will probably go for one of the following:
Discount mortgage - this offers a certain percentage off the lender's SVR for a set period, usually between one and five years. As the SVR moves, so does the pay rate on a discount mortgage, so you need to be able to cope if your monthly repayments increase.
Tracker mortgage - this also has a variable rate, this time linked to the Bank of England base rate. Sometimes this lasts for the length of the mortgage; sometimes it is only for a short period at the beginning of the loan. Some lenders offer discounted trackers, which have a rate that is a set percentage below the base rate, while others add a percentage to the base rate. Both deals move up and down in line with any changes announced by the Bank of England. This is great when rates are going down, but when rates are rising so will your mortgage repayments.
Fixed-rate mortgage - this allows you to fix the rate of interest you pay on your loan for a set period of time, usually between one and five years, although longer term fixes are available. This is useful if you are stretching yourself to afford a property, as your repayments cannot increase during the fixed-rate period. Fixed-rate mortgages can save you money if interest rates are rising, but if the base rate falls you can end up paying more than borrowers on variable rate deals.
A small handful of mortgages will track a different index to the base rate, often the Libor (London InterBank Offered Rate). It can be difficult to keep track of the rates on these loans, so they tend to be less popular with borrowers.
Most lenders apply early redemption charges during a fixed or discount period. This can make it costly to move your mortgage during that time.
Many short-term mortgage deals revert to the SVR after the initial offer period, which usually means increased repayments.
Interest-only or repayment
Once you've decided on the type of loan, your main decision will be whether to choose an interest-only or repayment mortgage. An interest-only mortgage does what it says on the tin - each month you repay just the interest incurred on your borrowing. The capital is only repaid the day the mortgage ends, and can be paid off using whatever money you choose - this might be cash from an inheritance or money built up in a separate investment.
However, this approach is not without risk. If you have not worked out how to pay off the mortgage by the end of the term you could be forced to sell off your home to settle the debt. Even if you use an investment to repay the mortgage it might not grow as much as you expect and you could end up with a shortfall at the end of the term.
This happened to many borrowers who took out endowments in the 1980s and 1990s to build up the cash to repay their loan. As the stock market did not perform as well as expected for several years, many homeowners found their endowments were not worth enough to pay off the capital at the end of the 25-year term.
Most people now go for a repayment mortgage, whereby both the interest and capital is repaid to the lender each month. This way you are guaranteed to have paid off the debt at the end of the mortgage term and you will own the house outright.
You can also have a mortgage split into part interest-only and part repayment, for example, if you have taken a top-up loan or want to keep the monthly repayments down on part of the debt.
Although there is no set definition for the term, a flexible mortgage is widely accepted to do the following:
· Allow you to overpay by any amount without penalty, including redeeming the loan
· Allow you to take payment holidays or underpay providing you have overpaid enough in advance
· Allow you to borrow back on the mortgage (or drawdown) without charging
However, not all flexible mortgages offer all of these features, and some are available on "regular" mortgages. You will need to read the small print to discover just how flexible a mortgage is.
This is a kind of flexible mortgage with an extra feature: you combine your borrowing with your savings to reduce the amount of interest you pay over the mortgage term. So, for example, if you have £10,000 in savings and a mortgage debt of £240,000, you will only pay interest on the remaining debt of £230,000.
You have to move your savings to your mortgage provider, and will miss out on earning interest on your money, but offsetting can make a big difference to the total cost of your loan. Your own money is kept in a separate pot and you can get hold of it whenever you need to.
Current account mortgages are a similar proposition, although they combine your day-to-day banking with your borrowing.
Offset and current account mortgages often have higher interest rates than other loans, and you need to make sure you have enough savings to make the deal worthwhile.
Applying for a mortgage
You need a job or a regular income to apply for a mortgage. To prove this, you will typically need to show the lender three months' of bank statements.
The Guardian, 15/04/15, www.theguardian.com
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