Types of Mortgage Product

Having decided on the overall method of repaying the mortgage, ie Capital Repayment, Interest Only or Part & Part, there are choices available as to the type of mortgage product you want. This is largely a personal decision which will be influenced by each individual’s perception of risk relative to their financial situation.

Fixed rate mortgage
Basically does what it says on the tin, in that you have a fixed rate of interest applied to your loan for a set period of time, ie 5.85% fixed for 2 years. Correspondingly, the monthly repayment will be fixed for the same period so the product will particularly appeal to first time buyers, young families and borrowers with large mortgages - anyone in fact who needs the stability of set monthly payments.
Fixed rates are generally a little higher than on variable products but this is easily compensated by the peace of mind offered.
Traditionally, fixed rate periods have centred on 2,3 and 5 years but some lenders are now offering longer term fixes of 7,10,15 and 25 years. Generally the product’s Early Repayment Charge (ERC), or penalty, runs to the end of the fixed rate period so thought must be given to choosing a product that doesn’t restrict future plans.

Tracker mortgage
The most common of the variable rate mortgages, it follows or tracks movements in the Bank of England Base Rate for a set period of time, ie Bank Base Rate (BBR) + 0.25% for 2 years. Trackers will generally offer lower rates than fixes but monthly repayments can fluctuate up or down in line with movements in BBR. This can appeal to borrowers who want lower monthly repayments but who can afford higher repayments if rates rise.

Many tracker products have a ‘collar’ clause built in to protect the lender should interest rates fall dramatically, ie BBR + 0.25% for 2 years but collar will apply if BBR falls to 3%. Most trackers will carry an ERC that matches the product period. Some ‘Term’ or ‘Life’ trackers, ie BBR + 0.5% for term of mortgage, do not carry any ERC and give a higher degree of flexibility, though the tracking margin will be a little higher.

Discount mortgage
Another variable rate mortgage, it works by offering a set discount off a lender’s standard variable rate (SVR) for a set period of time, ie SVR less 2% Discount for 2 years.
Each lender sets their own SVR but generally they sit around 2% above Bank Base Rate as a rough guide. Discount mortgages often offer the lowest monthly cost but repayments can fluctuate up and down as a rise in BBR will prompt lenders to raise their standard variable rate by the same margin. Note that if BBR drops by say 0.5%, lenders are not obliged to drop their SVR by the same amount. On this count trackers prove the better option as there is no ‘middleman’ effect - they are directly linked to Bank Base Rate.

Capped mortgage
On paper this product offers the best of both worlds as it guarantees that your interest rate will not rise above a ‘capped’ rate but allows it to fall if there is a drop in BBR. It might be offered as: 5.99% Capped at 6.50% for 2 years. The downside can be that the initial start rate, here 5.99%, is higher than 2 year fixed rates on offer – in effect you pay a little more for the possible benefit of a drop in interest rates during the product period.
Additionally, only a few lenders tend to offer capped rates so product choice is limited.
A good bet if you can ‘guess the market’ correctly and find a really competitive deal.

Flexible mortgage
Originally tagged the ‘Aussie mortgage’ due to it’s origins down under. Their concept was a mortgage where interest on the outstanding balance was calculated daily (rather than yearly as had been the tradition in the UK) with facilities for overpayments, underpayments and payment holidays.

Flexible mortgages are now a well established sector of the UK lending market.
While it is always beneficial to have interest calculated daily – many fixed, discount and tracker products now do this - flexible mortgages generally carry a slightly higher rate of interest so thought should be given as to whether all the ‘whistles and bells’ features are really needed. The most keenly priced fixed rates will often allow a 10% per annum overpayment facility - £10,000 on a £100,000 mortgage – which is usually more than sufficient for most borrowers. Why pay for a fur coat if all you need is a donkey jacket?

A self employed person with fluctuating or seasonal income might feel best served by a flexible mortgage – overpayments could be made in summer and normal or reduced payments in winter. A reserve built up from overpayments could be borrowed back to pay an income tax bill whilst less interest would have been paid on the mortgage due to the earlier overpayments. Interest saved from consistently overpaying and less fee expenditure on periodic remortgaging should outweigh the slightly higher interest rate.

Offset mortgage
The principle of an offset mortgage is to utilise savings funds to reduce interest paid on the mortgage borrowing, ie your mortgage is £125,000 but you have savings of £25,000 (the interest on which may be liable to tax). You elect to put your £25,000 savings into an offsetting ‘pot’ – the fund does not accrue any interest but you save by only paying mortgage interest on £100,000 for as long as £25,000 remains in the pot. You have ready access to your savings at any time. Some offset mortgages have a current account facility which allows your salary to add to the offsetting for as long as the account remains in credit.
As with flexible mortgages, offsets carry a slightly higher rate of interest but the aim is to save in the long term by paying less interest. This type of mortgage would be of particular appeal to a high rate tax payer who has a sizeable mortgage but also a substantial savings fund.

CAN WE HELP TO SECURE THE MORTGAGE THAT IS RIGHT FOR YOU?

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John Morgan trading as Mortgage of Choice is an Appointed Representative of Home of Choice Ltd which is authorised and regulated by the Financial Services Authority. Register No.302967 http://www.fsa.gov.uk/register/