For most people, your home is the most expensive purchase you will ever make, and very few people have enough money to pay for it outright. This means the majority have to take out a loan to pay for it. Mortgages are a special type of loan available to help you buy a house. There are different types of mortgage available, and it is important you find out as much as you can about these to make sure you get the right one for you.
How Much Can I Borrow?
You can usually get a mortgage from a bank, building society or other lender. The amount you will be able to borrow depends on what the lender believes you can afford to pay back. The lender should ensure they act responsibly, meaning they should not offer you more money than you can afford to repay, however it’s still important that you make sure you yourself are happy that you can comfortably afford the repayments, and think about what will happen if your circumstances change – will you still be able to afford your mortgage?
If you are a first time buyer you may be able to get special offers, and many banks have introductory discounts for new customers, or if you also hold your current account with them. Shop around to see what’s right for you, and if you are considering taking up an introductory rate offer, check to see when the offer ends and how much you will have to pay afterwards. Factor this into your calculations when budgeting to see how much you can afford to borrow.
The way a lender will calculate what you can afford to borrow may vary. Some lenders will work this out based on a multiple of your salary; others may make what is known as an ‘affordability assessment’ which is a basic calculation of your budget, much as you may do yourself, taking into account your income, living costs and how much you already owe on loans, credit cards etc.
Types of Mortgage
- A repayment mortgage is when you pay off the interest charged on the loan and make a small payment towards the loan itself each month. This is the most straightforward type of mortgage as it allows you to see clearly how your loan is being paid off. The downside is that your monthly payments may be higher than with an interest only mortgage; although a repayment mortgage should work out better value as you will get the loan paid off quicker and so be charged less interest overall.
- An interest-only mortgage is one where you only pay off the interest charged on the loan and don’t make any payments towards the loan itself. This means your monthly payments will be lower, however you will have to make arrangements yourself to pay off the loan itself at the end of your agreement. It can be tricky to make sure you will have enough money to do this. If you cannot afford to pay back the loan at the end of the agreement then you may be at risk of losing your home. This type of mortgage can also be more expensive in the long run as you are continuing to pay interest on the whole of your loan for the entire time you hold the mortgage.If you want to take out an interest-only mortgage you’ll need to think about how you intend to pay off the loan amount at the end of the agreement. You could do this by making regular deposits into a savings account, or through investments. You should consider taking advice from an FSA-registered advice agency before purchasing any financial product to ensure you get a deal that’s right for you, particularly if you feel unsure or you do not understand any of the information you have been given.
Whatever method of paying back your mortgage loan you decide on, you will need to keep an eye on your money to make sure you are on track to meet the cost of paying off your mortgage loan at the end of the agreement. If you find you have a shortfall you will be responsible for making up this money, so it may be worth having a backup plan in case something does go wrong with your investments. See http://yourmoney.moneyadviceservice.org.uk/products/mortgages/types/paying_back.html for more information about interest-only mortgages.
Interest Rate Deals
There are also different types of interest rate deals which you will need to consider. These can be either variable or tracker rates or a fixed rate. Variable interest rates may rise or fall according to how your lender decides to set them – this will usually depend on the interest rate set by the Bank of England (for tracker rates they will always move in relation to the Bank of England rate). Fixed rate interest on the other hand will stay at the same level regardless of changes in this ‘base rate’.
- Standard variable rate – This sort of rate may move up or down, depending on where your lender sets it. This sort of rate may reflect changes in the Bank of England’s interest rate. Standard variable rates often give you quite a lot of control, as you can usually pay back extra amounts as and when you like in order to reduce your interest payments without having to pay a penalty. However, your rate can go up at any time, and this can be quite an expensive rate compared to other deals.
- Tracker rate – Tracker rates are set to run at a certain level above or below the Bank of England interest rate or a similar ‘base rate’. This means your rate may rise and fall over the time you have the loan. This can be useful as you can save money when the rate is lower, but you must make sure that you will be able to afford higher payments if the rate goes up too. At the end of the deal the lender may transfer you to their standard variable rate (see above).
- Discounted interest rate – This is where you get the lender’s standard variable rate, but with a discount for a set period of time. Your monthly payments may go up or down, depending on the rate set by the lender. At the end of this discount period, you will usually change over to the normal standard variable rate. This sort of interest rate can be good as it means you don’t have to pay so much for your mortgage at the start, which can be handy as all the all costs of moving to a new home may mean money is initially quite tight. However you need to be aware that payments will go up when the deal ends and you must be sure you will be able to afford this increase or else be prepared to switch your mortgage (you may need to check if there is any penalty for this). You may also find that you are charged a penalty if you want to make extra repayments.
- Fixed interest rate – This means the rate you pay is fixed for a set period, giving you the security of knowing exactly what your repayments will be every month, which can make it easier to budget. However, if rates do go down, you will not be able to benefit. You may also have to pay a penalty if you wish to make any extra repayments towards your loan.
- Capped rate – With a capped rate mortgage your payments are variable and usually tied to a base rate but you also have a ‘cap’ – a certain level which your payments cannot go above. This is useful as if rates fall you can benefit from this, but if they rise you will have some protection. It can also help you budget as you know your payments can never go above a certain figure. You will usually be charged a penalty if you wish to make any extra repayments on your loan. At the end of the deal you may be switched to your lender’s standard variable rate. These rates are usually offered in combination with a ‘collared’ interest rate – see below.
- Collared rate – This is often used in combination with a capped rate and/or a tracker. Your payments will vary and may depend on a base rate; however they will never fall below a certain level. This means you will not get the full benefit of any fall in the base rate. Usually a collared rate is a condition of an offer which may otherwise seem quite a good deal, so you may be prepared to accept it.
This is only a brief run through of the different types of interest available. For more information see this website.