Mortgages - a step by step guide

Advice from Thames Valley's money-saving expert Melanie Wright on the different types of mortgages available and how to find the best one to suit you.

Fixed Rate Mortgages

As their name suggest, this type of mortgage is fixed at a set interest rate for a given period. This means that whatever happens to interest rates, your mortgage payments will remain the same during the fixed rate period. Fixed rate mortgages usually suit those on a strict budget who need to know exactly what their monthly outgoings will be.

Who they suit: Often a good option for first-time buyers who are struggling with costs. Knowing exactly what mortgage payments will cost for the first couple of years can make it much easier to budget effectively.

Capped Rate Mortgages

Capped rate mortgages get their name because there is a cap on the amount of interest you can be charged by the lender. In other words, the amount of interest you pay is guaranteed not to rise above a fixed percentage rate for a set period of time. But while rates cannot rise above a certain level, they can still fall.

Who they suit: People who can be flexible about their mortgage payments, but want the certainty of knowing they won’t go above a certain level.

Discounted Rate Mortgages

With this type of mortgage, you get a discount off the bank or building society’s standard variable rate for a set period of time. So, if your bank has a typical standard variable rate of 7.25% it might offer a discounted product which is 1% or 1.5% off this rate for two or three years. Remember however, that there is no cap on the amount of interest you can be charged which means that discounts may initially appear cheaper than capped rates, but this could quickly change if rates rise. However, if interest rates fall, your payments will drop.

Who they suit: People who are financially prepared for the fact that if rates continue to rise, their mortgage payments will too.

Tracker Mortgages

As their name suggests, tracker mortgages usually ‘track’ or follow Bank of England interest rates. Rates can either match interest rates exactly, or track them at a set percentage above or below. This type of loan can be risky if interest rates suddenly rise your payments will increase, but if they fall, then you could be on to a winner.

Who they suit: Those who think interest rates are likely to stay low for the next couple of years, and who don’t mind if their mortgage payments fluctuate over time.

Flexible Mortgages

A flexible mortgage provides the benefit of allowing borrowers to pay a lump sum off their mortgage at any time without penalty, or to take the odd repayment holiday. Because of this flexibility, these mortgages can be slightly more expensive than other deals.

Who they suit: If you anticipate that you may want to overpay on your mortgage to repay it more quickly, then a flexible mortgage could be for you. They are often attractive to those who receive large work bonuses which they want to put towards their mortgage.

Offset Mortgages

As their name suggest, offset mortgages allow you to ‘offset’ your savings against your mortgage. So, although you won’t be credited with any interest on your savings, you don’t have to pay any interest on the equivalent amount of your outstanding mortgage. This offset interest is then used to reduce the amount outstanding on the mortgage, which brings forward the date when it is totally repaid.

Who they suit: These are definitely mortgages for the long-haul and should not be contemplated unless you are fairly certain that you will be able to leave your savings more or less untouched over the mortgage term.

Self-certification

With a self-certification mortgage, you don’t need to show the normal proof of income, such as wage slips or accounts. You simply estimate what your income is, and, following the usual credit and electoral roll checks, the lender agrees to the mortgage. Self-certification mortgages do, however, tend to be more expensive than standard mortgages. This is generally because they are considered to be a higher risk for the lender.

Who they suit: These mortgages suit self-employed people, who can’t provide the usual three years worth of accounts required by lenders because they haven’t been self-employed for that long, or because they are paid in cash or are contract workers. They are also increasingly useful for those that get much of their income from rental or investment income, or other ‘non-traditional’ ways.

Interest Only vs. Repayment

Increasing numbers of people are opting for interest-only mortgages to help keep monthly costs down. But while this might be effective in the short term, it does mean you will end up paying much more interest in the long-term, as you aren’t reducing your mortgage debt. With an interest-only mortgage, as the name suggests, you only pay interest on the capital you owe. You must then set up a savings scheme, such as an individual savings account (Isa) which you pay into every month, so that you can repay the capital at the end of the mortgage term. With a repayment mortgage, however, you pay both the interest and the capital back each month. If you are choosing an interest-only mortgage because you are feeling over-stretched financially, then beware – if you are unable to make savings towards the capital you could face major problems later on.

Next month features producer Reshma Rumsey will be helping a family find the best savings and current accounts and have some investment tips.