Types of interest rate
The interest rate
The interest rate element of the mortgage is the most important. This is for one very simple reason.
It can change, and in doing so it may upset your household budget.
It is vital to understand that while you may buy a house today with a mortgage costing £400pm for example, interest rate changes could reduce that, or increase it.
In the past these changes have taken place very quickly. Just a few years ago the property market was very strong, and people were really pushing to get onto it. Some of them are now in negative equity (i.e. their mortgage is more than their house is worth).
For buyers this means that it is important to buy on the basis that it will be a home for a reasonable period of time, at least 2-3 years. In a flat market the transaction costs on buying/selling could eat into any profit you might hope to make, and since they would not be offset by gains made on the property, it might be better to rent. Talk to your mortgage adviser.
Also, if maxing out your budget on a mortgage, give serious consideration to a fixed rate mortgage for the first few years to protect you in the event of interest rate rises.
To see how rate changes could affect you use the interest rate calculator. You should note that rates are currently low (when compared to most of the past 25 years). If rates of 10-12% within the next few years would be unaffordable then be careful. Also experiment with rates of 8 - 9% - if they would be unaffordable within the next 3-4 years be very careful.
Types of interest rate contract
With the vast range of mortgage products available it might seem that you can almost pick and choose the rate you want to pay. One of the ways in which a mortgage adviser helps you is to sort through them and find the right one for you. While the interest rate is part of that equation, it is not the whole story. The overall structure of the contract is also important. Broadly speaking all good offers have to be paid for in some shape or form, and the question is do the advantages outweigh the disadvantages?
Floating/ standard/variable market rate
You borrow at the lender's normal rate of interest. No bells, no whistles and, normally, no early repayment charges if you want to move. The rate will vary as the market changes.
A 'Tracker' (changes in line with specified rate)
It follows a named interest rate in a fixed way, e.g. Bank Base Rate +1%. There may be early repayment charges on moving, depending on the deal.
Loyalty rate mortgages
Existing customers who meet the lender's criteria may be offered a discount to the standard rate.
Fixed interest rate
The rate is fixed at an agreed rate and for an agreed period of time. Your payments are not affected by either increases or decreases in the market Interest Rate during the agreed period.
When the fixed period ends you may be expected to stay with the lender and pay the full Standard Variable Rate for a further 1-3 years. If the lender has a reputation for being expensive with regard to its standard rates this would be something to take into account.
Early repayment charges can also be very high should you wish to break the agreement, and this is another area to assess. If you fix for 5 years and rates fall, you might want to switch to a lower rate. You are likely to find doing so very expensive, because of early repayment charges.
Because no one knows what future interest rates will be, fixed interest rates are best used when either they represent an attractive offer and way of saving money in the short term, and where the risk of losing out through downwards rate changes is one worth taking, or when you are concerned that rates may move upwards and that this would cause you serious problems with your budgeting.
Discounted interest rate
You get a discount on the standard variable rate for a given period – typically 2-5 years. If you decide to break the agreement, expect to face an early repayment charge during the discount period, and possibly beyond it. Be sure you understand the charges before signing.
These are mortgages that place an upper limit on your mortgage rate while still allowing you to benefit from reductions in interest rates.
Some schemes really are quite complex, and what may be given on one hand (a low interest rate) may be taken back with the other (an application fee).
These are mortgages where the lender offsets any interest on your savings deposits against the interest due on your mortgage.
They are popular but they are not for everyone. However if you have significant funds on deposit (which should not be invested elsewhere for the longer term), and the institution offers both a good deposit interest rate AND a competitive interest rate, then the package can be attractive. Your mortgage adviser can assess this for you.
Lenders are very inventive in what is an increasingly competitive market. The attractiveness of such offers would depend upon your situation.
All such offers need to be very carefully evaluated given your own particular circumstances.
Debt consolidation mortgages
These can be ideal for the right type of person – which is someone who has gone through a tough time but is now financially stable and confident, whilst not being considered suitable for normal mortgages, for example they are self-employed and have turned their business round, or they got into trouble after redundancy but now have a new and stable career.
But they can be a very expensive mistake indeed for the person who has a lot of unsecured debts to credit cards, car loans, utilities etc and who has not dealt with their fundamental problems. All too often they convert a bunch of creditors who would each accept a “whatever you can afford” payment into a single creditor who can, and will, force the sale of the house.
Selecting the right type of interest contract is a complex area, and the role of a mortgage adviser is to help you find the mortgage that suits your needs.
Think carefully before securing other debts against your home.
Your property may be repossessed if you do not keep up repayments on your mortgage.