Mortgages Explained

The mortgage market is famous for its jargon and technical phrases, which are often confusing and made unnecessarily comlicated. We have therefore provided brief descriptions outlining some of the main types of mortgage available.

Standard Variable Interest Rate Mortgage
With a standard variable rate (SVR) your mortgage lender sets the interest rate you pay. The lender bases this rate on the Bank of England's (BOE) base rate, and so when the BOE's base rate changes the standard variable rate will change. The SVR is usually between 2 and 4 percent higher than the BOE's base rate, but varies from lender to lender. The advantage of this is that when the BOE's base rate is low your monthly mortgage interest repayments will be low. Of course when the base rate is high you will be paying larger monthly repayments. This is one of the ways the British economy is manipulated, by controlling the populations spending.

With a variable rate mortgage you are able to switch lenders at any time without being penalised with early redemption penalties. If you start a mortgage with a different type of interest repayment for an agreed term, once the term finishes you will go back to the SVR. For instance if you agree to a fixed rate mortgage for a five year term, at the end of the five years you will have to pay the lenders SVR until the mortgage is repaid in full. For this reason when you are choosing a lender the SVR should be one of the most important factors to consider.

A standard variable rate is most suitable for someone who is likely to shop around to get the lowest interest rates, by re-mortgaging regularly. There are no redemption penalties with a SVR so you can switch mortgage lenders with no charge.

Discounted Interest Rate Mortgage
The discount mortgage rate is another variation of the standard variable rate. It provides a discount from the lenders SVR for a fixed period of time agreed between borrower and lender. Quite often the larger the deposit you provide the larger the discount will be. The same rule sometimes applies if the property price is very high. The interest rate still fluctuates, meaning your monthly repayments may differ slightly from month to month, but the discount remains constant. A discount rate mortgage is an incentive scheme used by mortgage lenders to attract new customers. Some discounted rate mortgages also include an element of cash back.

A discount rate mortgage might be most beneficial to first time buyers as the savings made in the early years of the mortgage could be used to furnish the house.

However, once again early and overhanging redemption penalties almost always apply so its worth finding out the lenders SVR as well so you know how much you'll be paying once the discount period ends. You may also be charged arrangement fees and possibly a MIG.

For meanings of terms please refer to glossary (see left information menu).

Base Rate Tracker Mortgage
A base rate tracker mortgage tracks the BOE's base rate and changes in accordance, with a constant differential, set by the lender. The result on your monthly mortgage interest payments is that they go up when the base rate goes up and they go down when the base rate goes down. The base rate tracker interest rate is usually between 0.5% and 1.0% greater than the B.O.E's Base Rate.

Base rate Trackers are usually available for a fixed term period agreed between borrower and lender, but can also be used for an entire mortgage term.

Lenders usually base the percentage differential (between the base rate and base rate tracker) on your homes LTV (Loan to Value)*. A home with a low LTV rate will more likely achieve a low base rate tracker interest rate, whereas a home with a high LTV will most likely give you a higher interest rate differential.

Although the base rate tracker mortgage is generally a low interest rate mortgage, and can be combined with a discount for a fixed period, it still has its downsides. As with all fixed period mortgage interest rate schemes many lenders will charge a redemption penalty if you wish to leave the mortgage scheme early. This is known as an early redemption penalty. Some lenders may also charge an overhanging redemption penalty. This is where the redemption penalty still applies after the base rate tracker fixed period is over, and you are on the lenders SVR. Another point about the base rate tracker is that it could be difficult to budget for as the BOE's base rate fluctuates

Flexible Mortgage
With a flexible mortgage you can make both underpayments and overpayments, according to your financial situation. For instance if you receive a bonus at work you could use it to pay your mortgage off quicker, and if you are short of funds you could take a payment holiday or even borrow money back; although different lenders have different policies on this. By paying your mortgage off early you could stand to save a lot of money in interest repayments. It is advisable not to make too many underpayments however, because you will find yourself paying a large amount of interest. Usually this type of interest rate is calculated daily meaning that you will see an
immediate impact of any overpayments that you make.

Different lenders have different rules on over and under payments. For instance some lenders may not allow you to underpay if you haven't overpaid in the past. Some lenders impose restrictions on the amount you can over and underpay.

This type of mortgage may be most suitable for self-employed, company directors of limited companies an contract workers.

Current account mortgage
A current account mortgage (CAM) combines the flexible mortgage with a current account. In other words you combine what you owe with what you own.

In the same way as a bank account your income is paid into your current account and partially used to repay your mortgage. Your lender will set a maximum borrowing limit, much like an overdraft, and provide you with a chequebook. The lender calculates the mortgage interest rate on a daily basis meaning as long as you keep up payments your interest rate should continue to fall. After all income and expenditure is calculated, at the end of the month, what is left will contribute towards paying off your mortgage.

As with most flexible mortgages most lenders will allow you to make over payments, underpayments and take payment holidays. For this service, and for a slightly greater than average risk to the lender, most lenders will charge a slightly higher interest rate.

Current account mortgages give you the ability to shorten the life of your mortgage term and therefore save considerable money by paying less interest.

If you earn regular bonuses and/or commission pay you will be able to overpay when possible if you have the discipline to do so.

Fixed Interest Rate Mortgage
A fixed rate mortgage allows you to repay interest at a fixed rate, irrespective of the BOE's base rate fluctuations. In other words you your monthly repayments will remain the same every month for a time period agreed between you and your lender (usually between 1 and 25 years). Once this period ends your mortgage will be transferred to a standard variable rate mortgage.

Usually with a scheme like this, where there is a fixed period involved, there is a redemption penalty charged for leaving the mortgage before the fixed rate term has ended. You may often find that this period continues after the fixed rate period finishes. This means you could find yourself tied into the mortgage for several years after the fixed rate period has ended. If the lenders SVR is high you are stuck with it, unless you pay the overhanging redemption penalty in order to leave the mortgage.

This is why the lenders SVR is often the most important factor to consider when choosing a mortgage deal. You may have a low fixed rate for a number of years, but if you are tied in for several years after the fixed rate has ended, you might find yourself paying a high SVR and losing all that you gained.

A fixed rate mortgage is most suitable in certain situations only. If the BOE's base rate is fluctuated unpredictably a fixed rate mortgage might be a good one to go for because your payments will remain the same so you can budget more easily. At the same time if the BOE's base rate remains consistently lower than your fixed rate then you would stand to lose a lot of money unless you could come to an agreement with your lender.
Another disadvantage associated with a fixed rate mortgages is that a lender might require a non-refundable up front booking fee to be paid on application to reserve the mortgage. Arrangement fees are also frequently experienced with this type of rate.

Cash-back Mortgage
With cash-back mortgage a lump cash sum is paid to the mortgage holder once the mortgage has been fully repaid. The lump sum will be a percentage (between 1% and 12%) agreed between lender and borrower. This type of mortgage is a variation on other schemes and can be used alongside an interest only mortgage for instance.

With cash-back mortgages you may have to pay application fees and an early redemption penalty charge. Usually the lender will require a non-refundable booking fee in advance.

Red Brick Financial Services
Berkeley House · 18-24 High Street · Edgware · Middlesex · HA8 7RP
Tel: 020 8952 4455 · Fax: 020 8952 4096 · Email: info@redbrickfs.co.uk