MORTGAGES EXPLAINED!
28th January 2015
Whether you’re a first time buyer, someone re-mortgaging or looking to buy an property for an investment the wide variety of mortgages can be a mine field.
There is so much choice when it comes to picking a mortgage, that it can seem totally baffling. Not only do you have to work out which mortgage will be the cheapest for you, which means looking at interest rates and fees, but there are also different types of product available.
So should you go for a fixed or variable rate deal? And what about offsets?
Fixed rate mortgage
The interest rate remains the same throughout the period of the deal – typically one to five years, though it is possible to get ten year fixed rates. If you opt for a fixed-rate, you’ll have the security of knowing exactly how much your mortgage will cost you for a set period of time.
Advantages
Your mortgage payments will remain the same, even if interest rates changed. This makes it great for budgeting.
Disadvantages
You are tied in for the length of the deal, so if interest rates fall you can’t take advantage of them. For example, if you opt for a five year fixed-rate deal, you will be tied in until the fixed term ends. If you want to get out of the mortgage before then, you’ll be charged a hefty penalty – often thousands of pounds.
So before you apply for a fixed rate mortgage, think about how long you are happy to be locked in for.
Tracker mortgage
The interest rate on a tracker mortgage is linked to the Bank of England base rate. So if the base rate changes, your mortgage rate will change.
The base rate is currently 0.50%, so if you took a tracker mortgage with a rate that is 2% above the base rate you’ll be paying an interest rate of 2.50% . If the Bank of England put the base rate up to 1%, your mortgage rate would increase to 3.00%. This would add about £25 a month to the repayments on a £100,000 mortgage.
As with fixed rate mortgages, trackers are available over different terms: most commonly two or five years. With these deals, you’ll be charged a penalty if you want to get out of the mortgage during the term.
You can also get lifetime, or term, trackers and these are often completely penalty free so they are very flexible and can be a great option if you don’t want to be tied into your mortgage.
Advantages
The rates on the leading tracker mortgages tend to be lower than on fixed rate deals.
Although trackers are variable rate mortgages, it’s easy to understand what rate you’ll be paying because they are directly linked to the base rate. Therefore, the rate, and your monthly payments, will only change if the Bank of England changes the base rate.
Disadvantages
You don’t have the same security with a tracker that you get with a fixed mortgage because the rate is variable. This means you have to be prepared for the fact that your monthly repayments could go up – and it’s really important to make sure you’ll be able to still afford your mortgage if this happens. If money is tight and you need to budget carefully, a fixed rate mortgage will probably be a better option.
Discount mortgage
Trackers aren’t the only type of variable mortgage. Discounts are another. However, unlike trackers the interest rate isn’t linked to the Bank of England base rate. Instead, it’s linked to the lender’s standard variable rate (SVR) and this is a significant difference because lenders can change their SVR even if there has been no change in the base rate.
A number of lenders have done this over the past year or so, and have increased their SVRs. This means their customers with discount mortgages have seen their repayments go up even though the Bank of England base rate hasn’t changed since March 2009. Discount mortgages are available over different terms – typically one to five years – and as with trackers and fixed rate deals you will probably be charged a penalty if you want to get out of the deal during the term.
Advantages
As with tracker mortgages, the rates tend to be lower than those on fixed rate mortgages. And because discounts are variable, the rate could fall as well as rise. If the rate were to fall, your monthly mortgage payment would reduce.
Disadvantages
The way discount mortgages are priced isn’t as transparent as tracker mortgages. Because the rate is linked to the SVR, not the base rate, the lender can theoretically change the rate at any time. So you may find your monthly mortgage payments rises when you’re not expecting it.
Before you take a discount mortgage out, make sure you’d still be able to afford your repayments if the rate was to go up. If it would be a struggle, opting for the security of a fixed rate would be a better option.
Offset mortgage
This is a more complicated mortgage as it links your savings to your mortgage debt.
Rather than earning interest on your savings, that money is set against your mortgage so you pay less interest on that debt. For example, say you have a £100,000 mortgage and £20,000 in savings, you would only be charged interest on £80,000 of the mortgage. However, your monthly mortgage repayments will have been calculated as if the debt was £100,000. This means you end up paying more than you need off your mortgage each month. As a result you clear your mortgage off more quickly and save yourself thousands of pounds in interest.
Some lenders give the option of reducing the monthly payments so that they are calculated on the mortgage amount once your savings are factored in. So with the example above, your repayments would be based on a £80,000 mortgage. This can be good if you want to save money now, but it won’t help if you are considering an offset to pay your mortgage off more quickly.
If you are considering an offset, you will have the choice of fixed or variable rate products, so consider the advantages and disadvantages of those as discussed above. Also, some offset providers will let you link your current account to your mortgage as well as your savings.
Advantages
As well as enabling you to knock years off your mortgage and save you thousands of pounds in interest, offset mortgages also offer a significant tax benefit.
Ordinarily, you pay income tax on any interest you earn on your savings. However, if you offset you have an offset you don’t earn interest on your savings so there is no tax to pay. An offset can therefore be particularly attractive for people in the higher or top rate tax brackets.
Disadvantages
The rates on offset mortgages tend to be higher than those on standard mortgage products so if you only have a small amount in savings, you may be better off just taking a normal mortgage and finding the most competitive savings rate you can.
Hopefully, this guide has helped you get to grips with mortgages a bit more, but if you are still unsure about what type of deal to go for, speak to an independent mortgage advisor. We’re partners with L&C Mortgages, which is a fee-free broker, so you can call them on 0844 776 1952 for more help. It’s well worth getting it right when it comes to your mortgage as it could save you thousands of pounds!
There is so much choice when it comes to picking a mortgage, that it can seem totally baffling. Not only do you have to work out which mortgage will be the cheapest for you, which means looking at interest rates and fees, but there are also different types of product available.
Independent financial advice is crucial and we are able to offer this through Simon Henning. From Urmston himself Simon will come and visit you in your home where he will go through your options. To book your appointment with Simon call HOME on 01617471177.