A mortgage is a loan that’s secured for the sake of purchasing a property. It can be a home, real estate property, and such like. The borrower gets from the lender the funds required to purchase the property. In return, the lender gets a promise from the borrower to repay the loan with some added interest. The mortgage document legally secures the contract and provides the lender with a legal claim against the borrower’s property in case they default on repayment terms.
The UK has different types of mortgage programs that are available for the borrowers. Taking a mortgage is a substantial financial requirement and having an understanding of the different types of mortgage programs can be of help.
Types of Mortgage
There are two types of mortgage that one can opt for; the difference lies in the rate of interest to be charged. These are; a variable rate mortgage and a fixed-rate mortgage.
A fixed-rate mortgage has a fixed interest rate. It means that the rate of interest will stay the same each month until the expiry date of the initial deal. This is an ideal option for those operating on a tight budget. The borrower is able to know in advance what they should be paying at the end of each month. A key advantage with fixed-rate mortgage is the fact that the monthly repayment doesn’t change even if the lender’s interest rates change.
It, therefore, becomes easier for the borrower to budget their finances. The borrower then has some certainty with the outstanding expenses. The major disadvantage with fixed-rate mortgages is when the lender’s interest rates fall, the borrower will then not be able to benefit from the reduced interest rates. Since the mortgage interest rates are fixed, longer deals are likely to have higher annual percentage rates than the shorter deals.
It makes it possible for the lenders to compensate for the money that they might have lost on monthly repayments in case of a rise in interest. Fixed-rate mortgage deals are also likely to include interest in overpaying or ending the agreement early.
Variable Rate Mortgages
Variable-rate mortgages are those with a fluctuating interest rate over the loan period. It means that the number of monthly repayments can change depending on the interest rates. The borrower should therefore be well prepared to handle the possibility of monthly rates increasing if there is an increase in the interest rates. Borrowers may also consider the possibility of the repayments coming down if there is a decrease in the interest rates. There are different types of variable-rate mortgages that one can consider;
Standard variable rate mortgages
This is the standard interest rate that’s set by lenders. It’s normally linked to the Bank of England’s base rate. Whenever the base rate goes, there is likely to be an increase in the mortgage rates and the monthly repayment rates. Since the standard interest is set by the lender, he can opt to either increase or decrease it during the period of the mortgage. SVR mortgages can be risky for the borrower especially if they are not able to afford the unexpected rise in the monthly repayments.
This type of mortgage should only be considered only by those who are financially secure and capable of coping with the fluctuations in the interest rates. The advantage with standard variable rate mortgages lies in the fact that the borrower is free to overpay or even leave the agreement without incurring any penalty.
Discount Rate Mortgage
This is where the lenders can offer a discount off the standard variable rate for a given period of time which can either be two to three years. The lower interest rates, therefore, mean that the monthly repayments can be worked out cheaper. However, when the period for discount rates come to an end, the rate of interest returns back to the standard variable rates as provided by the lender. The monthly repayment rates are also likely to increase in the process.
Since SVR rates differ between lenders, having a larger discount may not necessarily translate to cheaper monthly installments. For example, having a 2% discount on a 6% SVR will have a higher interest rate of 4%. Compare it to a smaller discount of 1.5% on 5% SVR; the interest rate payable is 3.5%. In discount rate mortgages, penalties might also be charged for ending the agreement early or overpaying.
Capped Rate Mortgage
In capped rate mortgages, the interest rate moves in line with the lenders SVR. This helps with establishing a measure of certainty that the repayment amounts will not go beyond the specified amount. However, it’s important to note that the capped rate of mortgages is higher than the SVR mortgages. This is because the borrower gets to pay for the added security.
A tracker mortgage is normally linked to another interest rate. It keeps moving up and down in line with the rate being tracked. For example, if the base rate that’s being tracked increases by 1%, your interest rate will also increase by 1%.
The tracked rate is normally the base rate that’s determined by the Bank of England. The tracker mortgage may last for a period of two to five years. However, there are lenders that might provide a rate that lasts for the entire period of the mortgage. One advantage of this type of mortgage is the fact that its fluctuation is normally determined by the rate it’s linked to instead of the lender.
Tracker mortgages may also attract early repayment charges, and that should be considered before opting to switch before the mortgage period ends. Tracker rate mortgages are also cheaper when compared to fixed-rate mortgages. Ensure that you take time to shop around so as to identify some of the cheaper rates available.
Interest Only Mortgage
Interest-only mortgages enable the borrower to pay off mortgage interest without paying for the capital. The monthly repayments may seem cheaper; however, the capital may still have to be paid at the end of the mortgage period.