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Mortgages made simple is a marketing website and not a lender or a broker. It does not sell or recommend mortgages.
Have more understanding of mortgage jargon.
Fixed Rate Mortgage Back to the top
With a fixed rate mortgage the amount you repay the lender each month can be at a fixed interest rate for a specified period of time, regardless of changes to interest rate in the market place. It is common for lenders to offer rates fixed for a period of 2 to 5 years, but shorter and longer periods can be found in the market. At the end of the fixed rate (or ‘benefit’) period the rate will normally convert to the lenders Standard Variable Rate (SVR).
It is normal for lenders to charge up-front fees in the form of booking and/or arrangement fees. In addition lenders frequently apply an Early Repayment Charge (ERC) for fixed rate mortgages. This acts as a ‘lock-in’ making an often heavy charge for borrowers paying off their mortgage early. Watch out, as the ERC can sometimes last longer than the fixed rate period e.g. a 3 year fixed rate with a 5 year ERC.
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Stepped Rates Back to the top
A stepped rate may be either fixed or discounted. The term 'stepped' simply means that the rate will change in steps at certain fixed intervals. For example a stepped fixed rate may offer a rate of 3% in year 1, 4% in year two and 6% in year three - in this example therefore you have a fixed rate for three years which increases in these three stages. An alternative to this may be stepped fixed rate where the interest rate decreases over the term of the fix. For example the rate may be 7% in year one, 5% in year 2 and 4% in year three. In this case the interest rate is again fixed for three years but at the three different steps.
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A stepped discounted rate will work in a similar fashion to the above but instead of the interest rate itself being fixed, the amount of the discount will be set. Again the size of the discount may step up or down over the period according to how the lender has chosen to structure the product. For example you may be offered a discount of 3% in year 1, 2% in year 2 and 1% in year three. Alternatively the step may be set in reverse with 1% off in year one, 2% in year two and 3% in year 3. Stepped rates have the same disadvantages and advantages of the fixed and discounted rate products and are simply a variation on the same theme. Again you should watch out for early redemption penalties.
Back to the top The stepped rate market is smaller than the conventional discounted or fixed rate market and fewer products are launched in this format. However, it is one that you should be aware of and one that will suit some people. Obviously individual circumstances and requirements vary considerably and these products will appeal to some people, particularly if they can see the stepped rate fitting in with planned changes in income.
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Discounted Rates Back to the top
Discounted rates are usually linked to the normal variable mortgage rate but with a discount for a set period of time. This means that the interest rate you are paying will fluctuate up and down in line with base rates but you will be guaranteed to receive the discount for a set period of time. Most of the discounted rates on offer at the present time will give the discount over the first one, two three, four or five years. The total amount of discount on offer tends to work out approximately the same over the period of the discount so, in broad terms, you are making a choice between a large discount for a short period of time, a small discount over a long period of time or something in between. For example one product may offer a 3% discount over 2 years and another a 2% discount over 3 years. The total discount you receive in either case is 6% so the choice you are faced with is what period to take the discount over. There are a few products that will offer the discount over a shorter period than one year and a few that will offer the discount spread over a longer period. There are even some lenders who will guarantee you a discount for the life of the mortgage and these products are certainly worth considering if you are not looking for a substantial reduction in your repayments over the short term.
Back to the top So, what are the disadvantages of discounted rates and what are the catches to watch out for? Broadly speaking, you have the same catches to watch for as for fixed rates. Look out for the early redemption penalties imposed on you by the lender. In particular watch out for products that have redemption penalties which extend beyond the period of the discount. If this applies to the deal you have taken then you will be tied to the lenders normal variable rate at the end of the discounted period and you will be denied the opportunity to rearrange your mortgage or negotiate better terms with your current lender without paying the redemption penalty. Also consider what the lenders normal variable rate is and has been in the past. Does the lender have a track record of charging a competitive rate or does their normal variable rate tend to be on the high side.
Back to the top The other advantages and disadvantages depend on what happens to interest rates over the period of the discount - if interest rates fall then you will take advantage of any reduction and see your monthly repayments fall. On the other hand if rates rise then your repayments will increase to reflect the change.
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In summary, therefore, you should probably avoid discounted rates if you are on a very tight budget unless you feel absolutely certain that interest rates will fall and remain low for the foreseeable future. However, if you are budgeting with a reasonable amount of leeway and you feel it is likely that rates will fall then a discounted rate could be just the thing for you and may save you a considerable amount of money over the early years of the mortgage.
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Capped Rates Back to the top
A capped rate will give you the best of both worlds between a fixed rate and a variable rate. The cap is basically a ceiling on the interest rate above which it will not rise. On the other hand, if the normal variable rate falls below the capped rate then the variable rate will be charged. So, you have a guaranteed maximum rate with the benefit of a reduction in interest rate if this happens - sounds too good to be true? Well there are some catches - first you will usually find that the cap is set at a higher rate than the best fixed rates for a similar period. So, for example, if a capped rate is offered for 5 years capped at 8% you may find the best five year fixed rate is being offered at 7%. Secondly, you also need to watch out for redemption penalties as with fixed rates. The third point to watch out for is that sometimes these products are sold as 'cap and collar' products. This basically means that, as well as a ceiling on the interest rate above which it cannot rise there is also a collar on the rate which is a level below which the rate cannot fall. For example a product may be sold with a cap of 8% and a collar of 5% for 5 years. This means that within that 5 year period the interest rate is guaranteed not to rise above 8% but it will also not fall below 5% within that time either. This means that if the normal variable rate falls below the collared rate you will be paying 'over the odds'.
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Tie in (penalty period) Back to the top
This is the amount of time that you have to stay with a particular lender without having to pay an Early redemption Penalty (ERP) to either pay off your mortgage or move to another lender. Generally for example the period of a fixed or discounted rate. i.e. a 3 year fixed product is likely to have a 3 year tie in.
Tie in Overhang
This is slightly different to the normal tie in period whereas after the fixed or discounted period you are generally tied in for an additional amount of time and you will be paying the lenders Standard Variable Rate.
Early Redemption Penalty (ERP)
This is the charge that you will have to pay to your lender if you chose to either pay off or move your mortgage whilst you are still within a tie in period.
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Overpayments Back to the top The starting point of all flexible mortgages is the ability to make overpayments on the mortgage. So why overpay your mortgage?
You may want to get rid of your mortgage debt as quickly as possible.
You may want to save money, which is achievable even through small overpayments. Underpayments Back to the top Truly flexible mortgages allow you to make underpayments. This facility maybe useful when you have times where you have additional expenditure. Most lenders will insist that you have previously made overpayments before they allow you to make any underpayments. Payment holidays Back to the top Many lenders will allow you to take payment holidays. Again they will usually require you to have made overpayments previously. For example if your mortgage payment is £500 per month, and you have previously made overpayments of £2000, then you would be allowed to take up to a maximum of 4 months payment holiday. Could be useful if you are planning some time travelling! Borrow Back Back to the top There may be occasions when you need to access a large sum of money. With many lenders you can borrow back your overpayments with a cheque book in your name. This is one of the features that encourages many borrowers to overpay in the first place. Early repayment charges Back to the top An early repayment charge may be made by a lender when you redeem (pay off or move) your mortgage. A truly flexible mortgage should have no early repayment charges, as the main benefit is to encourage borrowers to pay off their debt as quickly as possible. Interest calculations Back to the top A true flexible mortgage should calculate interest on a daily basis, this way any overpayments that you make would be credited immediately, and therefore the benefits kick in straight away. Almost every mortgage lender in the UK offers some form of flexible mortgage. And these days, even those mortgage deals which are not called flexible tend to come with a degree of flexibility, such as the ability to make overpayments and underpayments.
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What is a Flexible Offset Mortgage Back to the top A flexible offset mortgage makes your money work harder. You can use the balances in your current account, savings or ISA (dependent on which lender you use) to reduce the amount of interest you pay on your mortgage. Because interest is calculated daily, even if your balances change, you can still benefit. And, as you don't receive interest on your current account and direct access savings when offsetting, there is no tax to pay on the amount being offset. All Offset and flexible mortgages allow you to make overpayments, the more you overpay each month, the quicker you get rid of the debt, and you could potentially save thousands of pounds in future interest payments
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Repayment Back to the top
Your monthly repayments consist of repaying the capital amount borrowed together with accrued interest. On your mortgage statement, normally received annually, you will see that the outstanding balance decreases throughout the term.
Advantages of a repayment mortgage Back to the top
At the end of the term, you are safe in the knowledge that the total amount of the debt has been repaid.
Overpayments and lump sum payments into your mortgage account can be made, reducing both the interest and capital amounts repayable.
Life assurance cover is not always necessary in taking out this type of mortgage.
Disadvantages of a repayment mortgage Back to the top
There may be financial penalties for making lump sum/overpayments into your mortgage account. In the early years of a repayment mortgage the majority of the monthly repayment is interest rather than capital. For borrowers moving house regularly, this can result in little of the capital being paid off.
If you have no life assurance cover in place and die before the loan is repaid, the mortgage will still need to be repaid. This may result in the property having to be sold to repay the debt owed.
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Interest only Back to the top
With this type of mortgage, each mortgage payment is only used to pay off interest. At the same time, the borrower takes out an alternative ‘repayment vehicle’ (method of paying off the mortgage) such as an ISA, pension plan or endowment policy. More information on endowments (which in the 1980’s and 1990’s were extremely popular), ISAs and Pension plans is set out below. The most important fact about an interest only mortgage is that the monthly repayments do not repay any of the outstanding capital balance. As a consequence it is important that the payments are maintained into the repayment vehicle; otherwise it will not be possible to pay off the mortgage at the end of the term.
Endowment Back to the top
This is the most common type of interest only mortgage which also provides life assurance cover and a fixed payment for investment. The fixed payments are based on the amount of the loan together with the mortgage term and are designed so that, at maturity, the amount invested and earnings are sufficient to pay off the mortgage. Much maligned in the press because of the poorer investment growth rates achieved in a low inflationary environment, this form of investment is less popular these days. Note there is no guarantee that, when the endowment matures and ‘pays out’, the balance will be sufficient to repay the mortgage. Back to the top
Nonetheless millions of borrowers have one or more endowment policies and as a rule of thumb, these should not be cashed-in early and certainly not before seeking advice from a suitably qualified financial adviser. Customers cashing-in an endowment policy in the first few years after inception can receive less than the amount invested. Existing endowments can be used to support a new mortgage with any ‘additional lending’ over the value of the projected maturity balance being covered on a repayment basis or with an alternative repayment vehicle e.g. an ISA. It is also worth pointing out that, historically, the returns on endowment policies have been pretty good (provided they go full term).
Endowments provide life assurance so that in the event of death the mortgage is paid off.
ISA Back to the top
The Individual Savings Account (ISA) is a tax free method of saving. Using an ISA as a repayment vehicle is growing in popularity but due to the ISAs complexity it is only for the financially sophisticated or borrowers taking advice from a suitably qualified financial adviser.
Pension Plan Back to the top
Life assurance cover is provided and monthly payments are made into a pension fund. When the benefits are eventually taken, the mortgage is repaid using tax-free cash from the remainder of the fund. The plan holder can then draw a pension from the balance of the fund. This product, which tends to be used by the self employed, is only for those taking advice from a suitably qualified financial adviser.
Advantages of an interest only mortgage Back to the top
If the proceeds of the plans exceed the amount required to repay the mortgage, then this is received as a cash lump sum by the borrower.
Some plans are tax-efficient.
Disadvantages of an interest only mortgage Back to the top
If the proceeds of the repayment vehicle do not achieve the amount expected, then there will be a shortfall. The borrower remains liable for any shortfall on the mortgage hence the outstanding balance will need to be paid off from other resources. Regular checking of the policy fund itself by the borrower and the lender should minimise any risk. If the plan is not reaching its expected target, the borrower can increase payments into the policy or invest in another product to cover any anticipated shortfall.
Cashing in the plans early may result in financial penalties. These will be provided for in the initial agreement. In addition the lender has no way of tracking some of the more modern repayment vehicles, such as an ISA, which will result in some instances where a borrower lets an investment lapse forgetting or not realizing it is to be used to pay off the mortgage. This will result in situations where there is no method of paying off the mortgage and the lender will only become aware at the end of the mortgage term.
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Advantages/ disadvantages of Cash back incentives Back to the top
Advantages
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The additional cash can be useful at a time when you may have little spare cash. The money can be used to pay solicitor's fees, buy furnishings, carpets etc. You could even put the money into a savings account and use it to assist in making mortgage repayments in the first few months or years.
Disadvantages
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Early redemption penalties will almost certainly apply. This means you will be unable to change your mortgage during the 'early redemption penalty period' without paying back the lump sum received, or paying a fee, which may be up to the value of six months mortgage repayments. Consequently, you may end up being trapped in a mortgage with an uncompetitive rate.
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You may have to pay an application fee when arranging your cash back mortgage.