Information about Mortgage types and different Mortgages

There are essentially two different types of mortgage:
Repayment (capital and interest mortgage)
Interest only (ISA, pension or endowment mortgage)

Repayment Mortgage

With a repayment mortgage you repay the capital amount borrowed together with accrued interest. On your annual mortgage statement you will notice that the amount borrowed decreases throughout the term of the mortgage. The advantage of this type of mortgage is that at the end of the term, you are safe in the knowledge that the total amount borrowed has been repaid. Overpayments and lump sum payments into your mortgage account can be made reducing both the interest and capital amounts repayable. Life insurance cover is not always necessary in taking out this type of mortgage, but it is advisable because if you were to die before the loan is repaid, the lender will still want their money back. This may result in the property having to be sold to repay the debt owed.

The disadvantages of a repayment mortgage are that there may be financial penalties for making lump sum or overpayments. In the early years of a repayment mortgage the majority of the monthly repayment is interest rather than capital. If you are looking to move house regularly you may find that you are paying very little off the initial amount borrowed.

Interest Only Mortgage

With an Interest Only mortgage, only the interest is paid with each mortgage payment not any of the capital borrowed. The borrower should also take out an alternative ‘repayment vehicle’ to pay off the capital at the end of the term. There are several repayment vehicles available such as an ISA, pension plan or endowment. It is important that the payments into the repayment vehicle are maintained throughout the term of the mortgage otherwise it may not be possible to pay off the mortgage at the end of the term.

Endowment Policies

Endowment policies which were very popular in the 80's and early 90's came in for a rough ride in the mid to late 90's with claims of mis-selling amid interest rates dropping and poor investment growth causing the possibility that the endowment policy taken out may not have built up enough money to be able to pay off the mortgage at the end of the term. The adverse publicity has made the endowment less popular. There is no guarantee that  when the endowment matures and pays out that there will be sufficient to repay the capital borrowed. Despite this millions of borrowers have one or more endowment policies. These should not be cashed in early and definitely not before seeking advice from a suitably qualified adviser. If you cash in your Endowment within the first few years of starting it, you will find that you are likely to receive less back than you paid into it. Existing endowments can be used to support a new mortgage with any ‘additional lending’ over the value of the projected maturity balance being covered on a repayment basis or with an alternative repayment vehicle e.g. an ISA. It is also worth pointing out that historically the returns on endowment policies have been good, although past performance is is not a guide to future performance. Endowments provide life assurance so that in the event of death the mortgage is paid off.

ISA's

The Individual Savings Account (ISA) is a tax free method of saving. Using an ISA as a repayment vehicle has grown in popularity since the bad publicity of endowments, but due to the ISAs complexity it is only for  the financially aware or borrowers taking advice from a suitably qualified adviser.

In general the lender has no way of tracking some of the more modern repayment vehicles, such as an ISA. It is all too easy not to pay money into an ISA in times of hardship, this should be avoided at all costs. This could result with no method of paying off the mortgage and the lender will only become aware at the end of the mortgage term.

For other methods that may be available to repay your mortgage feel free to call one of our advisers for independent advice.

Interest

Whether you have an interest only or repayment mortgage, you are going to have to pay interest on your borrowing, these are usually in one of the following four guises; Fixed, Capped, Discount or Variable.

Fixed Rate

With fixed rate interest you repay the lender each month at a fixed interest rate for a certain period of time regardless of the interest rate in the market place. Fixed interest rates tend to be over a period of 2 to 5 years but shorter and longer periods can be found. At the end of the fixed rate period the rate will normally revert to the lenders Standard Variable Rate.

It is normal for lenders to charge fees in advance in the form of booking and/or arrangement fees. Lenders also frequently apply an Early Repayment Charge for fixed rate mortgages which acts as a ‘lock-in’ making an often heavy charge for borrowers paying off their mortgage early. This lock-in sometimes last longer than the fixed rate period, for example you may have take nout a 3 year fixed interest mortgage and find that you are locked in for five years, meaning that you will either have to pay the Standard Variable Rate for two years or face paying an early redemption charge.

Capped Rate

A capped rate mortgage is very similar to a fixed rate mortgage except that if the variable rate drops below the capped rate the borrower will make payments based on the lower variable rate. However should rates increase the payments will be ‘capped’ and will not rise over the capped rate. So, in general a capped rate is better to have than a fixed rate mortgage if all things are equal. As with fixed rates, up-front charges and ‘lock-ins’ are common.

Discounted Rate

A discounted rate of interest is where the lender offers a discount on the Standard Variable Rate for a specific period of time. For example, the variable rate may be 5% with a discount of 1.5%. The initial rate would therefore be 3.5%. If the variable rate rose to say, 6%, then the rate payable would rise to 4.5%. As the discount is linked to the standard variable rate, the borrowers payments will increase if interest rates rise so there is no certainty in budgeting. However should rates decrease the borrower will benefit from lower payments. Again up-front charges for discounted products and an Early Redemption Charge is common. Beware of lenders offering large discounts, for example e.g. 4% off for 1 year. Such offers look good for the inexperienced but you will find that you will face a significant increase in your monthly mortgage payment at the end of the discount benefit period.

Standard Variable Rate (SVR)

Interest paid at the lenders standard variable rate will increase or decrease as the lender adjusts the rate in accordance with market conditions.

So, having decided on the type of mortgage, possible repayment vehicle and the type of interest there are still other factors to take into consideration when choosing the right mortgage for your circumstances.

Flexible Mortgages

Some lenders offer Flexible or ‘lifestyle’ mortgages. These are designed to let you to make extra repayments when you have extra money, and to reduce or even skip payments if necessary. Borrowers normally have to build up a reserve through making overpayments before being allowed to underpay or skip payments. The big benefit of flexible mortgages is that many schemes are offered on a Daily or Monthly Interest Calculation basis. On a mortgage where the interest is being calculated on a daily basis, any over-payment reduces the mortgage balance immediately, hence the borrower will be charged less interest from the next day. Overpaying your mortgage on a monthly or regular basis, even by a relatively small amount, will reduce your mortgage term by years. Most flexible mortgages come without any Early Redemption Charge so the borrower is not locked-in to any particular lender. In addition the interest rate charged is often lower than the usual Standard Variable Rates charged by the other more ‘traditional’ mortgage lenders.

Another type of flexible mortgage is one linked to a current account. These mortgages take the benefits of the flexible mortgage and use the funds held in the current account to offset the interest. For example, if on a particular day a borrower has a mortgage balance of £50,000 and has £2,000 in their current account, the customer is charged mortgage interest on £48,000 i.e. the mortgage balance minus the positive balance held in the current account. Some more recent versions of this type of mortgage are also incorporating savings accounts, credit cards and personal loans into the mix. This is very useful for having all your banking in one basket and being able to keep track of your finances.

Cashback Mortgages

Some lenders offer cashback as an incentive for you to have your mortgage with them which will pay you a lump sum of cash once the mortgage has been taken out. The amount varies from lender to lender and on the size of the mortgage. The amounts typically range from a flat fee, for example £200, to a percentage of the loan, for example, 3% of the mortgage. Pre cashback offers can be found but are normally offered as part of a package of benefits, for example, linked with a discount. Mortgages offering a cashback of up to 6% can be found which would mean a borrower taking a £70,000 mortgage with 6% cashback would receive £4,200 on completion. The downside of cashback mortgages is that they invariably have Early Redemption Charges and lock in clauses, usually for 5-10 years.

Other Incentives

A common mortgage package aimed towards the remortgage market is where the lender offers to pay for conveyancing. The lender usually asks that the solicitor is chosen from a list provided by them.

Some lenders offer free valuation. Normally when you apply for a mortgage, the lender instructs a valuer to value the property that they are going to lend you the money to buy. Typically you are asked to foot the bill for this in advance. However, where free valuation is offered you will still be required to pay up front for the valuatiuon, with the cost of the valuation refunded to you if and when the mortgage is completed. If the mortgage does not proceed for any reason, the valuation fee will not be refunded.

As if you are not confused enough already with the choice, there are other things to be aware of such as conditions and charges associated with mortgages.

Early Repayment Penalties

The Early Repayment Penalty (or early redemption charge) is normally applied by lenders to mortgages which are offered at an initial subsidy, or loss leader, for example, a discounted rate mortgage. So, to ensure the lenders do not lose out on interest payments by borrowers moving their mortgage as soon as the discounted rate ends, they apply ‘lock in’periods and Early Repeayment Charges for those paying off the mortgage early. Charges can be significant, for example, 6 months interest or repayment of the amount of benefit received, be it cashback or reduced interest. The period of time and the amount of any penalties due will be stipulated at the time the mortgage is taken out. Sometimes these will match the period of the discounted or fixed rate but often it lasts beyond the benefit period, for example, a 5 year discounted rate may have a 7 year early redemption charge. This is known as a ‘repayment overhang’. Early repayment charges equal to six months interest are not uncommon and therefore can be expensive.

There are 'no redemption' mortgages available which enable you to repay the loan in full at any time without having to pay an Early Repayment Charge. However, there may be other fees to pay in advance, such as sealing fees and legal fees. As the borrower is not locked in to these mortgages, the rate of interest are typically not as competitive as those for mortgages with redemption penalties. This type of mortgage is really suitable for those looking to remortgage quickly if they find a better rate, or those who are looking to repay their mortgage in full within the first few years.

Also 'No overhang' mortgages exist which allow you to repay the loan without penalty once the benefit period has ended, for example, the mortgage has an Early Repayment Charge but it does not last longer than the fixed, capped or discount period. This means that a mortgage with, for example, a discount to 31st January 2006 will have a repayment charge to either the same date or a date prior to this. Again sealing fees and legal fees may apply and the rate offered may not be as competitive as for rates with redemption overhangs.

Higher Lending Charge

The Higher Lending Charge (HLC) (formerly known as a Mortgage Indemnity Guarantee (MIG)), is normally asked for by the lender on mortgages with a high Loan to Value. That is, where the loan is not much less than the value of the property. It is common practice for the lender to take out a form of ‘insurance’ to protect them against the risk of losses incurred if the property needs to be repossessed due to  mortgage payment arrears. Lenders pass the cost of this inurance on to the borrower. The cost of the higher lending charge can be significant. A £47,500 mortgage on a purchase price £50,000 would result in a £750 charge on a typical HLC of 7.5% on a normal lending limit of 75% loan to value. Despite the fact that the borrower pays for this insurance it is in place to protect the lender. Beware that even if you do pay a Higher Lending Charge, you will still be liable for any shortfall between the sale price of the property after repossession and outstanding mortgage payments plus any arrears, legal costs and any other charges. The insurance company that the Mortgage Indemnity was taken out with will pursue you for this money.

Valuation Fee

As mentioned earlier, lenders charge potential borrowers a valuation fee when they apply for a mortgage. It is important to note that this valuation is for the benefit of the lender, not the applicant. Lenders also frequently include an administration fee as part of the valuation fee to cover the costs of arranging the valuation. The valuation does not represent a detailed inspection. It is advisable that any prospective purchaser obtains a ‘Housebuyers Report’ or a ‘Full Structural Survey’. These are more detailed than a lender valuation and produced on behalf of the applicant, and also more expensive. This process will be Changing in August 2007 with the introductionof the "Home Information Pack (HIP's)", but whether the lender will still also require the borrower to pay for a valuation is still unknown.

Other Fees

Other fees that may be charged upon application of the mortgage are Booking Fee and Arrangement Fees.

A booking fee will normally be required with the application form, this is used to reserve funds on a mortgage product that has limited funds available, for example, a first-come, first-served fixed rate. Booking fees are usually non-refundable, so if the mortgage applicant cancels the mortgage application before completion the fee will not be reimbursed. An arrangement fee is normally charged upon completion of the mortgage application. These can normally be added to the mortgage and are more often found when applying for a fixed and capped rate mortgage.

When purchasing a property it is necessary to have a solicitor or licensed conveyancer to act on behalf of the mortgage applicant and the lender in the purchase or remortgage transaction. The costs are greater for house purchase than for remortgage due to the extra work involved. It is the role of the solicitor or conveyancer to note ownership of the property on the title deeds; note the lenders interest in the property; register with the Land Registry and conduct searches to identify if there may be factors which could affect the property, for example, coal mining search to check for subsidence; check to see if any Motorways are planned to go through the back garden, etc.

Lenders may also charge other fees. In accordance with the Mortgage Code of Practice the lender will, before a mortgage applicant takes a mortgage, provide a tariff covering the repayment of the mortgage, including charges and additional interest costs payable in the event of arrears and will advise of any other charges for services before or when the service is provided. These charges normally apply to arrears, late payment and removing the lenders name from the Title Deeds at the end of the mortgage.

Bad Credit

If a borrower has a bad credit rating this is referred to as Adverse Credit. Poor Credit history can include County Court Judgements(CCJ), Bankruptcy, Mortgage arrears or any late payments on credit arrangements. Mortgage arrears are either measured in the amount, or months that are in arrears. Bankruptcy is where a Corporation, Firm or individual who, via a court proceeding, is relieved from paying all debts once assets have been surrendered to an appointed third party designated by the court. A County Court Judgement is a ruling by a County Court against a person who has not satisfied their debt payments with their creditors. Once the ruling has taken place it will be recorded against the persons credit history and will appear every time a credit search is done for the next seven years. They will also find that the mortgages that are available to them will be at a higher interest rate.

Home Insurance

Buildings insurance is usually insisted on by the lenders. The typical buildings insurance covers against storm damage, fire, flooding, etc and relates to the fabric of the property. Lenders will normally check that any policy arranged is adequate and a fee may be levied for them to check the policy if the borrower takes out a policy other than the one sold or recommended by the lender. However, it is worth shopping about for your buildings insurance as there can be better deals available than the ones recommended by the lenders which will save you money in the long run. Borrowers ought to have a Contents insurance Policy that provides cover for the contents of the property. Most lenders and insurance companies offer a combined Buildings and Contents Policy.