Mortgage Types

You should seek further advice after reading this page and it should be understood that the information contained is not advice specific to your circumstances.

On all mortgages there are charges that must be assessed before proceeding. On some types of mortgages there are penalties which you should make yourself aware of. On all mortgages then your home is at risk if you do not keep up payments on any borrowings secured on it.

Fixed rate mortgages

They do exactly what they say. They fix the rate for a set period. This offers stability and provides a simple way to budget ahead. If rates go up (as they have been doing) then you also save money as your rate remains the same until the end of the selected period. The disadvantage of a fixed rate mortgage is that if interest rates drop you'll be tied into your set higher rate until the end of the agreed period. So you won't see any decrease in your monthly repayments. At the end of the two- to five-year term borrowers will typically be converted to the standard variable rate. A final disadvantage is there are often penalties if you want to leave the fixed rate deal early – watch out as they can be very high.

Variable rate mortgages

If you go for a variable rate mortgage you'll pay the lender's standard variable rate of interest (SVR). This is linked to market conditions, which means that if the Bank of England puts the interest rate up - it's likely your SVR will also go up and vice versa. Recently mortgage lenders have been putting up rates even though the BOE has been bringing rates down.

If you go for this product you may gain if interest rates drop because your payments will follow suit and you could end up saving money on your mortgage. But you should also be aware if rates go up so will your repayments, and take this into account when calculating your budget.

Discount rate mortgages

With discount rate mortgages the interest rate you pay is set below the SVR for a specific period. For example, if the SVR is five per cent, your rate could be four per cent, giving you a one per cent discount. Then if the variable rate rose to six per cent yours would rise to five per cent.

As with the variable rate, this would mean that you could benefit from lower payments but they may go up as well as down. One major consideration of a discounted rate mortgage that must always be born in mind is that at the end of the discounted term your mortgage repayments WILL increase back to the standard rate. A final disadvantage is there are often penalties if you want to leave the fixed rate deal early – watch out as they can be very high.

Cashback mortgage

A cashback mortgage will give you a lump sum back once you've completed your purchase. This can either be in the form of a set amount or a percentage of the amount you have borrowed (typically three to six per cent). However, they do come with restrictions, namely that if you repay the mortgage in full within a given time (three to five years) then the cashback must be repaid. Then you may be able to also ‘add-on’ one or more of the other options listed on this page as well.

Capped rate mortgage

Capped rate mortgages are basically a mixture of the fixed rate and discount rate mortgage. A maximum interest rate is agreed for a set period of time but if the SVR drops below that rate you'll pay that lower amount. In other words the mortgage interest rate may fluctuate up and down below the specified rate, but may not go above it. Some capped mortgages will not only have a 'ceiling' but also a 'floor' between which the rate payable may move. These loans may be known as cap and collar mortgages.

Flexible mortgages

Flexible mortgages are designed to allow you to alter your repayments to suit your situation. If some months you feel you'd like to pay a little extra, you can. Also, if you decide that you would like to pay less or take a break completely for a period - you can do that too. But you'll probably be asked to build up a reserve through overpayments beforehand.

They're branded under many different titles such as 'personal choice mortgages' 'open plan' or 'freedom mortgages'. The common trait is that most flexible mortgages charge interest on a daily or monthly rate which means if you can pay more than the set repayment, on a regular basis, you could reduce the term of your mortgage and save money.

The sort of features that these mortgages may offer include the following:

  • monthly overpayments (so that you reduce the term and save on interest)
  • reducing/stopping payments during times of financial hardship
  • payments over ten months rather than 12 months
  • payments four weekly (that is, 13 times a year)
  • lump sum payments
  • cheque books to allow withdrawal of a pre-determined further advance

Some flexible mortgages are also current account mortgages or offset mortgages:

Current account mortgages

See also flexible mortgages above. Current account mortgages combine your current account with your mortgage - so in effect you have a very large overdraft. The advantage is that when your interest is calculated on the sum you borrowed, the funds you have in your current account are taken off the loan.

So if you borrow £100,000 and you have £3,000 in your account you'll only be charged interest on £97,000. You could end up paying off your mortgage quicker.

Offset mortgages

See also flexible mortgages above. With offset mortgages you have separate accounts but again the funds you have in savings or current accounts are taken into consideration when you interest is calculated. This could be an advantage as with the current account mortgage and all your accounts are in one place which may make them easier to manage.

When deciding if this is the product best for you it's worth looking at the different benefits and drawbacks of the various accounts.

For example, the mortgage arrangement may be suitable but you may get a better deal on a different current account. It's really only worth considering an offset mortgage if you generally have a healthy amount of credit in your other accounts.

Dated 1 June 2008 – valid for 6 months. Aisa Direct Ltd, authorised and regulated by the FSA as Independent Financial Advisers. 1 Fordbrook Business Centre, Pewsey, SN9 5NU

* This newsletter has been prepared with all possible care to ensure its accuracy. It is based on our current understanding of legislation and HMRC practice. 

* Neither Aisa Direct Ltd nor any of its employees can accept responsibility for any errors or omissions. You should seek further professional advice prior to action.

This should not be deemed as individual advice and you should seek further information particular to your individual circumstances. For further information, contact AisaProfessional on (01672) 569111.