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Mortgages

A mortgage is best known as a loan that you can take out in order to purchase your home. Mortgages can also be provided in order to purchase investment properties also.

Mortgages are offered by ‘lenders’ which are commonly banks and building societies. Generally, lenders will require the borrower to lay down an initial deposit on their property and then borrow the remainder to purchase the house as a mortgage. The proportion of deposit that is paid to the amount borrowed is known as the ‘Loan to Value’ or LTV. The rates that lenders offer generally become more competitive as the LTV value decreases as their risk becomes lower. For example, someone buying a house for £200,000 and paying £20,000 deposit will need to borrow £180,000. The LTV in this case is 90%. If the borrower was paying a higher deposit and thus decreasing the LTV, it is likely that they would be able to find a more competitive rate. A financial adviser should be able shop around for rates on your behalf.

Mortgage lenders often offer customers different promotional rate options for a specific period of time. It is most common to see promotional rates offered for 2, 3 or 5 years although they may offer other terms. The rates offered are often linked to the lender’s Standard Variable Rate or the Bank of England Base rate. The most common types are fixed and discounted/tracker rates. A fixed rate is a defined rate of interest offered for a specific period of time regardless of what happens to interest rate changes in the UK. This is good for budgeting as the payment will remain the same for the agreed period. This could workout favourable if interest rates increase but could go against you in interest rates fall. A discounted/tracker rate mortgage will change depending on the lender’s standard variable rate or Bank of England base rate. If there are interest rate changes, then the payments will vary and it is not so good for budgeting. However, payments will reduce if interest rates fall but payments will increase if interest rates rise. Generally a discounted rate will follow the lender’s standard variable rate and a tracker will follow the Bank of England base rate. If the Bank of England base rate changes then tracker payments will automatically change, however it is up to the lender to decide whether to pass on this rate change to their discounted rate customers by changing their standard variable rate as they are not obliged to do so. With fixed rates and discounted/tracker rates, once the promotional period has ended, the interest rate will usually revert back to the lender’s standard variable rate until the end of the term of the mortgage. It is therefore common for people to change their mortgage lender once the promotional period is over to start a further promotional rate of interest. This is known as a taking out a ‘remortgage’. This is usually done after the promotional rate has ended with the current lender as remortgaging prior to this can incur redemption penalties with the current lender, which can be expensive.

There are two common options for repaying a mortgage. These are ‘repayment’ and ‘interest-only’. A repayment mortgage pays back each month a proportion of capital and a proportion of interest for an agreed term. As the outstanding capital decreases each month, the outstanding interest decreases each month and throughout the term of the mortgage the proportion that pays off the capital increases and the interest proportion decreases. At the end of the term, as long as all of the payments have been kept up, the mortgage will be paid off in full. An interest-only mortgage only pays off the outstanding interest on the mortgage each month for an agreed term but does not pay any capital. The borrower therefore is usually recommended to take out an investment vehicle to run alongside the mortgage for the same term to build up to the value of the property. At the end of the term, the proceeds from the investment would then be used to pay off the outstanding mortgage amount. This will only happen however if the investment vehicle reaches the target value intended by the end of the term.

As well as the options described above, there are lenders who offer flexible options for mortgages which may combine types of interest or repayment method. It is important to go through all of these options with a financial adviser and find the most suitable product for your circumstances.

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