Different types of mortgages are available in the market namely: interest only mortgages, repayment mortgages, part repayment and part interest mortgages. In fact, there are approximately four thousand mortgage packages currently in the market!
A mortgage is an instrument that gives a legal title of the land or any other property to the lender (mortgagee) as a lien by contract. It is a security against the debt to the lender, and the borrower (mortgagor) can purchase property without paying the full value up front. However, the legal title does not give any powers to the mortgagees to do whatever they like with the real property.
Mortgages fall under two main categories:
Interest Only Mortgages
As you make your interest payments towards the loan, the capital that you have borrowed, eg the monthly capital installment, is simultaneously committed into an investment fund. This investment fund will most likely have exceeded the borrowed capital by the end of the mortgage period. You will also have earned some extra money. The lenders themselves offer an investment product in which you make payments. You are not under any obligation to invest in this product. You should have a look around for the best transaction. For a more favourable tax advantage compared to others, you can use an ISA or individual savings account. There are two types of ISA — the cash type and the equity type. You can even consult qualified personal finance specialists who deal with mortgages. The financial advisors have access to computer programs which search the entire market for your specific needs.
For repayment mortgages, the property is actually guaranteed to be yours at the end of the mortgage. You pay a small amount towards the capital with every payment and the balance goes to the interest until the entire debt is paid. The monthly installments will be on the higher side. However, your payment will be reducing your actual debt and no separate investment scheme is required to pay off the property.
A combination of the above two mortgages is also available and is called the “part repayment, part interest only mortgages.”
The Bank of England sets the interest repayment — the base rate of interest for both types of mortgage. These rates include:
- Fixed Rate - The interest rate for your loan is fixed for a set period, usually between 1 and 5 years.
- Variable Rate - set at a rate higher than the Bank of England set base rate. Commonly between 1% and 2%, but can be higher. “Tracks” the base rate and fluctuates along with it. You can take advantage of low interest rates, but you will be the loser when the interest rate rises. A difference of 1% on a £100,000 mortgage can mean the difference of £1000 a year.
- Capped Rate - The maximum amount of interest you will pay over the agreed term is limited or capped by the borrower and the lender. If interest rates fall, your rate falls along with it. Therefore, technically you can take advantage of the falls and are somewhat protected from the rises in the base rate.
- Discount Rate - A discount on the normal variable rate is offered here. When the base rate and variable rate changes, your payments will fluctuate and you will actually end up paying less. The agreed term with the lender is fixed and you can’t switch to another lender.
The mortgage scene is very competitive and can be confusing. Therefore, it is always safer to consult an independent financial advisor or IFA for professional advice before availing any type of mortgage loan.