There are two mortgage options available for individuals, these being the repayment plan or the interest only plan.
The repayment plan consists of monthly payments in order to pay back the borrowed amount as well as any interest that has been accrued. There are several advantages and disadvantages to the repayment mortgage plan which should be considered before making a mortgage decision.
Some of the advantages to the plan include the fact that once the mortgage term is completed, no more additional debt is owed. In addition to this, with this plan, overpayments can be made in order to decrease the amount of interest and capital amounts of debt.
In addition, unlike interest only mortgages, this type of mortgage does not always require life assurance. Although these are all positive aspects of repayment mortgage plans, there are also a couple of disadvantages. Some financial institutions require additional financial compensation if overpayments are made. In addition, although there might not be a requirement for life assurance, the mortgage still needs to be paid should the owner of the mortgage die before the completion of the payments. This sometimes results in the property being sold by family members who are not able to pay off the rest of the debt.
Interest only Mortgage
As opposed to repayment mortgage, the interest only mortgage plan involves the monthly payment of only the interest. In other words, the payments do not pay off the actual balance of the debt. In addition, the borrower takes out an endowment policy, Individual Savings Account (ISA), or pension plan. These act as a “repayment vehicle” by which the balance can be eventually paid.
The first and most common type of interest only mortgage is the endowment policy. This type of mortgage provides both a fixed payment as well as life assurance. Each of the payments takes into account both the capital amount of the loan as well as the term of mortgage so that, at the end of the term, the amount generated through payments and earnings is enough to pay off the entire debt. Because the endowment policy provides life assurance, the death of the borrower would result in the mortgage being paid off.
The ISA or Individual Savings Account is the second type of interest only mortgage and allows for borrowers to save in a tax free manner. The ISA is a more complex form of repayment vehicle so it is not recommended that a borrower utilise this plan unless they are financially apt or have a professional advisor for their finances.
The last type of interest only mortgage plan consists of payments being made monthly into a pension plan. Like the endowment policy, life assurance is provided which means that the mortgage will be paid should the borrower die before the debt is eliminated. The debt is paid by using the tax free cash from the pension fund. The borrower is then able to take a pension from the remainder of the funds. Like the ISA plan, the pension plan should only be utilised by those who have access to a professional financial adviser.
As is the case with the repayment mortgage plan, an interest only mortgage also has its pros and cons. Some advantages are, for example, that if the amount of money in the fund exceeds what is required to pay the debt, the borrower is able to receive the remaining funds as a lump sum. In addition, some of the plans allow for tax free money to be set aside for payment use. There are, of course, accompanying disadvantages.
One such disadvantage is that there is no guarantee that the correct amount of money will be available in the fund at the end of the mortgage term to pay off the debt. Despite this, the borrower is still responsible for any balance of mortgage debt. Another disadvantage is that, if one were to prematurely cash in the plan, a financial penalty may be inevitable.
Interest Rates on Mortgages
Once a type of mortgage has been decided on, the next step is to choose an option for mortgage rates.
Fixed Rate Mortgage
A fixed rate mortgage is one in which a specific interest rate is set for a period of time. The rate during this time period will not change regardless of whether or not the interest in the market increases. It is only after this specified period that the interest rate will be adjusted to the SVR or Standard Variable Rate.
With this form of mortgage, lenders will typically charge an initial fee at the start of the arrangement as well as an Early Repayment Charge or ERC should the borrower choose to pay their debt earlier. Some lenders will even have their ERC last for a period longer than the fixed rate so as to ensure that the institution will not lose out on interest charges.
Capped Rate Mortgage
The second form of mortgage rate is the capped rate which means that if the interest rates decrease, the borrower pays the lower rate. However, if the interest rate increases, the borrower is required to pay no more than a set “cap” rate. This is the most desirable mortgage rate.
Discounted Rate Mortgage
With the discounted rate, the lending financial institution provides a discount for a set period of time. The discount is set to a specific percentage meaning that, if the Standard Variable Rate or SVR increases, the rate will increase but will still remain discounted by the set percentage. As is the case with the fixed rate plan, the lender may charge up front fees or charge an Early Repayment Charge. One disadvantage to this is that the lender may offer a large discount for a short period of time and then dramatically decrease the discount percentage.
Variable Rate Mortgage
This rate varies with the SVC or Standard Variable Rate.
Tracker Rate Mortgage
The tracker rate mortgage is a form of variable rate which rises or falls a certain percentage amount above a certain base rate such as the London Interbank Offered Rate (LIBOR).
Features and Other Benefits Offered with Mortgages
With a flexible/lifestyle mortgage plan, a borrower is able to make extra repayments or skip a payment depending on their needs. Typically, lenders do not allow borrowers to skip or reduce payments if they have not already established a surplus through overpayments.
The benefit of the flexible mortgage is that, instead of being charged interest annually, the interest is calculated daily so an overpayment immediately adjusts the balance of the debt. This effectively reduces the interest. The typical flexible mortgage is not accompanied by an Early Repayment Charge and the interest rates are usually lower than the market rate.
CCJ and Bad debt mortgages
This is a specialist product and requires a specialist broker such as CCJ Mortgages
Mortgages, known as Current Account Mortgages or CAMs, combine the benefits of a flexible/lifestyle mortgage with funds located in a savings and/or current account to offset accrued interest. This means that interest is charged on the mortgage balance minus the amount located in the account. If the borrower chooses to offset their mortgage using this method, they should be aware that the money in their accounts will not receive interest.
The lending financial institution will occasionally offer a cash incentive when the borrower chooses to take out a mortgage. The amount of the lump sum varies depending on the lender as well as on the amount of the mortgage.
Some lenders will offer up to a 6 percent cashback incentive which, with a normal sized mortgage, would result in a significant return. These cash incentives can either be given as a flat lump sum in a set amount or as a percentage of the mortgage amount. In the majority of financial institutions, the cashback incentive is delivered as a continuous benefit such as a discount. However, there are some lenders who will distribute a pure cash sum. However, with the incentive of a cashback, lenders often apply an Early Repayment Charge for a period between five to seven years in order to ensure that the lender does not lose out on large amounts of interest.
Free Legals or a Contribution Towards Conveyancing Costs
In order to gain the benefit of these advantages, the borrower of the mortgage is typically required to utilise a soliciting firm or a licensed conveyancer chosen by the lending financial institution. This is typically done during the remortgaging process although it can also be used as a mortgage “enhancement”.
Free Valuation or Refund of Valuation
A refund of valuation can occur once the application of the mortgage has been completed whereas a free valuation does not require any payments. Therefore, if one pays for a valuation but does not go forward with the mortgage due to a bad valuation, for example, the refund will not be made.
Other benefits and incentives that can be included with a borrower’s mortgage include no Early Repayment Charge and no Higher Lending Charges from the lending financial institutions.
Remember your home is at risk if you fail to pay your mortgage the UK government offers mortgage help online with good advice.
The Council of Mortgage Lenders states on their site “policy work provides a vital link between lenders, government and other key stakeholders. We work with the industry to identify and communicate policy across a wide spectrum – from valuation issues to arrears and possessions. Our policy pages will give you an insight into our key policy positions through to our written communications to ministers, civil servants and other policy makers or influencers”.
FinanceNet hopes you found this guide informative.