Taking out a mortgage was once as simple as heading down to a local building
society and having an interview with manager.
Now, there are 5,450 different mortgages on the market, from around 150
lenders. Instead of going straight to a building society, you might instead
trawl two or three price comparison sites, chat to a couple of lenders, and
also visit a few banks, before choosing your loan.
Get your choice right, and you could save yourself hundreds of pounds a month
in interest. Get it wrong, and you could make life much harder than it needs
to be to meet your repayments.
The basics
Mortgages are a loan secured against your property, which means that if you do
not keep up repayments, the lender could request that you give up your home
so that it can sell the property and make its money back.
Lenders will usually offer you an initial "deal", which will consist
of a competitive interest rate over a set period of time. Once that deal
period comes to an end, the lender will put you on what is called the "Standard
Variable Rate." This is usually much higher than the initial deal
you were on.
Avoiding the high SVR repayments is the reason that people switch mortgage
deals and lenders so often, although sometimes SVRs can be more competitive
than some of the deals on offer, and come with fewer restrictions, so it is
important to check.
The Bank of
England base rate gives an indication of the cost of borrowing in an
economy. Although most mortgage rates do not match the base rate exactly,
they do tend to go up and down roughly in line.
Tracker rates go up and down exactly in line, pegged at a rate a set amount
above or below the base rate, so for borrowers with these deals, movements
in the Bank of England base rate are more crucial.
Fixed rates
These are deals where the interest rate is fixed at a certain level for the
duration of the deal. Most lenders offer a range of 2, 3, 5, 7 and 10 year
fixed rates, although it is possible to fix for as long as 25 years.
Usually, the longer you fix for, the more expensive the rate.
The advantage of having a fixed rate is that you know what your monthly
repayments will be, giving you security and the ability to budget.
The disadvantage is that if interest rates do fall, you miss out on the
opportunity to make savings.
Fixed rates are determined by swap rates, which are the money markets where
lenders buy what they call "tranches" of funding. Fixed rates were
worst hit by the credit crunch, because lenders stopped lending to each
other.
Tracker rates
As mentioned above, these "track" the Bank of England base rate, by
a certain number of percentage points above or below.
On these deals, your repayments come down if the base rate goes down, and up
if the base rate goes up.
When economists expect the base rate to come down, you can expect that tracker
rates will usually carry a slightly higher premium to cover the risk to the
lender.
Variable rates
Unlike trackers, these can go up or down by more or less than movements in the
base rate and at different times.
As well as the standard variable rate, you can get "discounted"
variable rate deals. These often offer big discounts initially, making
them look more attractive than other tracker and fixed rate deals, but then
borrowers risk above average rises should interest rates begin to creep up.
Offset mortgages
Offset are an ingenious concept that only works in practice if you have a lot
of savings. These work by reducing the amount of interest you owe on your
borrowings by "offsetting" them against your savings balance. So
if you had a mortgage worth £100,000 and savings of £20,000, you would only
be charged interest on £80,000.
Interest rates on offset deals are typically higher than on standard mortgage
deals, so the general advice is that they are only really worth considering
if you have savings worth at least 10 per cent of your mortgage.
Current account mortgages, such as the One
Account, follow a similar logic, with your current account balance being
offset against your mortgage. The main downside to this is that you have to
get your head around seeing a balance that is always a minus number, such as
-£98,546, which some people find a little scary.
Fees
When you take out a mortgage, it is not as straightforward as simply paying
interest on a loan, there are all sorts of other costs to consider. These
include arrangement
fees, which lenders charge just for setting up the mortgage, valuation
fees, to cover the cost of valuing your property and legal fees, to pay the
solicitor for doing the necessary legal paperwork when you take out a deal.
Potential costs do not end there. If you redeem the loan before the tie-in
period is up, you will probably have to pay an early redemption fee, often
about 3 per cent of the loan. This is another reason why many borrowers
prefer shorter-term deals.
Many lenders also charge exit fees, of around £200 to £300. However these have
been heavily criticised for being unfair, and in cases where you have been
charged a fee in excess of what you signed up to, lenders will refund you.
See our guide on how
to claim.
Overpayments
Most mortgage deals allow you to over-pay by up to 10 per cent of the balance
each year. If you want to pay off more than that, you should opt for a deal
with more flexibility. Some deals are fully flexible, allowing for
overpayments, underpayments, and payment holidays, for months when you are
tighter on cash.
These deals often suit the self-employed, because of the erratic nature of
their incomes. However they come with a premium for the privilege.
"Drop-lock"
These deals are relatively new in the mortgage lexicon. They begin as a
tracker, but allow borrowers to "drop" into a fixed rate if
interest rates fall and the borrower thinks they would like to remain on
that rate. The idea is that if you think interest rates have fallen as far
as they are going to go, or are in danger of going up again, you still have
the option of fixing.
The term
Mortgages are usually repaid over a term of 25 years, because traditionally,
spreading the repayments over this term brings them to a more affordable
level. However, it is possible to extend or reduce the term, depending on
the lender's conditions.
Extending the term reduces monthly repayments but increases the overall amount
of interest you will have to pay. Reducing the term means you will have to
increase your repayments, but will be mortgage-free sooner.
However not all mortgage deals offer the facility to change the term. If they
do, you may have to pay a premium on the rate.
Arrears
Failing to keep up with repayments is called arrears.
Your lender will normally take your property back off you if you are more
than six months in arrears on your loan, and if you do not have an
alternative repayment plan in place.
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Five features
Q&A:
What to do if you face repossession
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Five websites
Mortgages made clear
- the FInancial Services Authority
Moneyfacts - mortgages
What Mortgage Magazine
Mortgage broker: John Charcol
Mortgage broker: London & Country
