Understanding the main options

Mortgages have become increasingly complex in recent years as the market has become more competitive. Borrowers now need to consider at least two things: the type of loan they want and how they are going to repay it. Here are the main options:

Types of loan

Variable rate: Rates on these loans fluctuate in line with general interest rates but because they are at the lender’s discretion they don’t necessarily move as far, or as fast. Discounts are usually offered to new borrowers in the early years.

Tracker: Rates on tracker loans are normally linked directly to movements in the Bank of England base rate. The link may be for a limited period rather than the life of the mortgage.

Cashback: When these loans are granted, cash payments are given to borrowers to spend how they like. They are typically between 6 per cent and 8 per cent of the loan.

Fixed-rate: Rates of interest on these loans are guaranteed not to change for a specified period, typically the first three to five years of the mortgage. A few lenders offer 25 year fixed-rates.

Capped-rate: With this type of loan, the interest rate is guaranteed not to exceed a fixed level during the capped-rate period. The advantage is that it can go down if rates are cut.

Methods of repayment

Repayment: Also known as capital and interest mortgages because part of the monthly payments gradually pays off the loan while the remainder covers the interest on the amount outstanding.

Offset: These loans are taken out in conjunction with a current account or savings account. Regular mortgage repayments are required but at the same time the cash in the other accounts helps to reduce the loan, thereby saving interest. This can help to speed up repayment of the mortgage.

Interest-only: As its name implies, the borrower pays the interest only on the loan during the mortgage term so the capital remains outstanding. Payments may also be made into a savings scheme, such as an Individual Savings Account, to repay the capital at the end of the term. Sometimes the loan is repaid out of the sale proceeds of the property.

Endowment mortgage: This is where an interest-only loan is combined with a life assurance with-profits policy intended to pay out a sufficient sum to clear the mortgage at the end of the term. But endowment policy payouts are not guaranteed and many are currently expected to produce shortfalls.

Your home may be repossessed if you do not keep up repayments on your mortgage.
Article date: 12.06