What is a mortgage?
A mortgage is a loan made to you by a lender so you can purchase a property. You’ll pay interest on the mortgage and your lender will use your home as security for the loan. This means that your lender may repossess your home if you do not keep up repayments.
Repayment options
At its most basic level, a mortgage has two parts – the loan (the money you borrow) and the interest (the charge made by the lender until the loan is paid back).
The most important points are how you pay back the loan you borrow and how you pay the interest on it. You can either pay interest plus a little loan each month (a repayment mortgage) or just pay interest each month and pay all the loan off at the end of the mortgage term (an interest-only mortgage). A repayment mortgage is widely considered to be the easiest to understand and the least risky type of mortgage.
Repayment mortgages
With a repayment mortgage, your monthly payments pay off the interest due each month plus a little of the loan you owe. With this type of mortgage, you have the benefit of seeing your mortgage amount get smaller over time.
Plus, when the mortgage comes to an end, you’ll have paid off everything you owe in full and have nothing left to pay (which wouldn’t be the case if you’d opted for an interest-only mortgage).
Of course, you should remember that in the first few years of paying a repayment mortgage, you’ll be mainly paying off interest. So, if you want to repay the mortgage early or move house, you’ll find the amount you owe won’t have gone down by very much.
Interest-only mortgages
The name of this type of mortgage says it all. With an interest-only mortgage, your monthly payments only pay the
interest on the amount you’ve borrowed; you won’t actually be reducing the loan itself. This means that at the end of the mortgage term you’ll still owe the full amount of the loan.
With an interest-only mortgage you’ll need to make sure you have put plans in place to pay off everything you owe at the end of your term, for example an investment or savings plan. You’ll also need to take the cost of doing this into account when comparing the costs of interest-only and repayment mortgages.
An interest-only mortgage is a higher risk than a repayment mortgage. In most cases, there is no guarantee that you will be in a position to fully repay the loan amount you owe at the end of the term. That’s why you need to keep an eye on your intended repayment plan throughout the life of the mortgage to make sure it’s growing accordingly.
It is your responsibility to make sure you have a plan in place that helps you repay the balance. You need to make sure you’ll have enough money at the end of your mortgage term to repay your loan, because if you don’t you could lose your home.
Types of mortgages
When you apply for a mortgage, you’ll be able to choose from several different types of deals. Most lenders offer a range of options on their mortgages, including:
- fixed-rate mortgages
- tracker mortgages
Fixed-rate mortgages
Your interest rate will stay the same for a set period. Many lenders offer fixed rates for two, three, five or ten years, sometimes longer. The benefit of a fixed-rate mortgage is that it helps you to budget more easily, because your interest rate will stay the same for the length of the deal. Early repayment charges will almost always apply if you switch away from the mortgage before the fixed rate period ends.
Tracker mortgages
With this type of mortgage, the interest rate tracks a rate that is outside the control of the lender, such as the Bank of England bank rate (also known as the Base Rate). Every time that rate goes up or down, so does the interest rate on your mortgage.
Naturally, you will be better off whenever the interest rates drop and your monthly payments will be less. But you should make sure your budget will allow you to make higher monthly payments if interest rates were to go back up. Early repayment charges will sometimes apply if you switch away from the mortgage before the tracker deal period ends.
Buy-to-Let mortgages
With a buy-to-let mortgage, you take out a mortgage on a property that you intend to rent out. Lenders have different criteria for these types of mortgages, so it’s best to shop around and consult an independent financial advisor who can give you the most current information. Buy-to-let mortgages have become less commonplace following the financial crisis of 2008/09, but they are still available to people who qualify.
You should be aware that when you buy to let, you become a landlord. You will own an investment property and this is not the same as owning your own home. You are running a small business and you must be prepared to put in some work to make this business a success (for example, find tenants, collect the rent, make repairs, etc).