All mortgages work in the same simple way. You borrow money to purchase a property over a set number of years and pay interest on what you owe.
The amount you pay back each month is based on how much you borrow, the interest rate charged and the number of years selected. Also, whether your mortgage is on a Repayment basis or Interest Only basis.
What is the difference between Repayment and Interest Only?
The majority of mortgages are arranged on a repayment basis – also known as capital and interest. This essentially means for every payment you make you will repay a proportion of the capital borrowed as well as pay an element of interest on what you owe. Assuming you meet all your payments at the end of your agreed mortgage term you will owe nothing to the lender and your home shall be mortgage-free / owned outright.
Interest-only is very different. This means you are only paying the interest on the amount borrowed and the capital amount you owe will not reduce. At the end of your mortgage if you have only paid interest you will still owe the full amount borrowed from the outset. Not everyone is eligible for Interest Only and certain criteria would need to be met for this to be considered. Speaking to an advisor is the best way forward if you are considering this type of mortgage.
What are the different types of mortgage rates?
- Fixed Rate
- Variable Rate
Fixed rate mortgage is you pay a fixed payment for a set term, normally this will be from two to five years but can be longer than this. A fixed rate will give you peace of mind as your monthly payments will be the same every month and if interest rates change you shall be unaffected.
In simple terms if you have a variable mortgage it means you payments could go up or down over time. Most lenders have a Standard Variable Rate (SVR) which is the rate the lender charges when a borrowers mortgage deal comes to an end. When a borrower is on a lenders SVR it usually suggests they are no longer tied in or under penalty so you could be eligible to move away to a new lender or take a new deal.
Tracker rate mortgages, will track a nominated interest rate plus a set percentage for a certain period of time. Most lenders tend to follow the Bank of England (BOE) base rate. When the BOE base rate increases your mortgage payments would increase by the same % percentage amount. If the BOE base rate decreases your mortgage payments would go down by the same % percentage amount.
A discounted mortgage rate offers a reduction from a lender SVR for a set amount of time. Normally, this may be for two to five years. Similar to a tracker rate your rate can go up or down.
Capped rate mortgages
Similar to a variable rate mortgage, capped rates can go up or down over time, but the Cap is a limit which your interest rate cannot go above. This can give you some certainty that your payments would not exceed a particular amount.
An offset mortgage enables you to offset your savings against your mortgage. Rather than earn interest on your savings you are charged less on your mortgage debt. A borrower can choose to reduce their monthly payment as result of reduced interest charge or choose to reduce the mortgage term by paying it off at a faster rate. The right option will depend on individual circumstances and what you are hoping to achieve.