Choosing a Mortgage

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When choosing a mortgage there are so many different ingredients that add to the mix - so it's vitally important that you get the best advice to help you get the 'blend' right. Our step-by-step guide to choosing a mortgage will give you all the information you need to help make the right choice. We have grouped what you need to know under the following headings:

Step 1: How much can you borrow?
Step 2: Choosing your type of mortgage
Step 3: Choosing your repayment method

Remember our advisers can give you full details of all the options available and give you advice on a suitable one for you - according to your individual circumstances.

How Much Can You Borrow?

Before you start searching for a home you need to know how large a mortgage you can get – there’s no point in finding the home of your dreams if it’s outside your price range.

Traditionally most lenders calculate the amount they will lend you by multiplying your gross annual income by a factor of 3 or more. If you are buying a property with someone else the lender will usually lend 2.5 times both your incomes or 3 times the higher salary plus 1 times the lower. For self employed people the same multiples are used but are generally based on the average net income from the last 2-3 years accounts.

Need to borrow more?

Lending limits are carefully set to make sure that borrowers don’t over commit themselves, however with mortgage rates very low at present some lenders will consider using higher lending multiples. If you feel that you need to borrow more than the standard income multiples then call us and we can source those companies that can help you.

Most lenders require a deposit of at least 5% although there are a few companies who will offer 100% mortgages where no deposit is required. If you do not have a deposit then call us to see if we can help you obtain 100% mortgage.

Choosing your type of mortgage

Standard variable rate (SVR) mortgage

A variable rate repayment mortgage is the most common type of loan - if only because you revert to this rate at the end of the lender's initial offer period. The interest rate goes up and down during the lifetime of your mortgage, broadly in line with interest rates in the economy as a whole. This means that when the interest rate goes up, the amount you have to pay also goes up. When the interest rate falls, your payments come down. They are suitable during periods of interest rate stability or when rates are falling and usually free of Early Repayment Charges.

When the interest rates change, some lenders adjust the amount they charge borrowers immediately. Others wait until the end of their financial year before making the change. Some lenders offer a way of levelling out interest rate changes over the year. The interest rate goes up and down in exactly the same way, but your payments change only once a year. This doesn’t usually save you money but it does allow for easier budgeting for the year ahead.

Discount mortgage

With a discount mortgage the lender offers you a set percentage reduction on its standard variable rate (SVR) over a given period. For example, your lender may offer you a discount of 1.5% off its SVR of 6.50% for 2 years. For the first 2 years of your mortgage, interest on your mortgage would be charged at only 5.0% assuming that the lenders own standard variable rate remains the same throughout that period. If the lender raises its SVR to 7.00% then interest will be charged at 5.5% and therefore your monthly payments will rise. Should the lender lower its SVR to 5.5% however, then the interest charged and your monthly repayments would fall.

Tracker mortgage

This works in a similar way to a discounted mortgage but is often seen as a fairer system of offering reductions on mortgage rates. Lenders have the right to change their SVR regardless of changes to the base rate. Base rate tracker mortgages bypass this by mirroring exactly any changes to the base rate, usually within thirty days. Interest is charged at a set percentage – typically 1% above the base rate. You benefit instantly from any drop in interest rates, don’t have to wait for the lender to pass on cuts, but your payments will increase automatically if the base rate rises. Many lenders are now setting out mortgage products on the tracker basis rather than using the discount method. For example a lender might offer a product which is 0.5% over the Bank of England Base Rate (BBR) for 2 years. Assuming that the current BBR is 4.75% then the tracker will be 5.25% to start with and will then go up and down as this rate fluctuates, and hence your mortgage payments will also rise or fall.

Fixed rate mortgage

A fixed rate loan gives you a guaranteed rate of interest for an agreed period of time. This can be very comforting if you have a large mortgage or on a tight budget because it guarantees that the payments will not rise.

However if interest rates fall, your mortgage payments will remain the same until the end of the fixed term, so you should think carefully about how long you want to be locked into the same rate. Fixed rates are generally available from 1-10 years or even longer with 2-3 year fixes the most popular. When the period ends your mortgage usually reverts to the lenders own standard variable rate. It usually makes sense to choose a fixed rate when you think that rates are likely to rise. Do be aware that most fixed rates have Early Repayment Charges if you want to switch or repay the mortgage before the scheme ends. It’s important to check whether you can transfer the deal to a new property if you move to keep the original deal and avoid the penalties. More and more lenders are offering fixed rates with an option to make overpayments subject to a certain limit without incurring penalties. As independent brokers we can advise you of those companies that make allowances for overpayments.

Capped rate mortgage

A capped rate is a compromise between a fixed rate and a variable rate mortgage. Your mortgage rate still goes up and down, but you have the comfort of knowing that when the mortgage rate goes up it will not exceed a certain figure. This is known as the ‘capped rate’.

They are a safe option to consider. If you had a fixed rate mortgage and rates fell, your repayments would not fall in line with the decrease. With a capped rate mortgage however you benefit from any fall in rates.

With the capped rate mortgage however you are may not receive the cheapest rate on the market. Better deals can be found on fixed rate or discounted mortgages because in theory the caps offer the best of both worlds. But if rates fell, you’d save more with a discount and if they rose you would have been better off with a fixed rate. Some capped rate mortgages have a ‘collar’ – if interest rates fall below a certain level your mortgage repayments will not track them below that point.

Flexible Mortgages

With flexible mortgages you can pay in extra amounts to reduce your outstanding loan or build up a reserve of money you can draw on in the future. Some mortgages allow you to vary or even suspend payments for periods of time.

Interest is calculated daily (or monthly in some cases) so the benefits of overpayments are immediate. This means you could end up saving a significant amount on your mortgage. You may even be able to pay it off early. The flexibility of being able to reduce or stop payments for a while can also be useful, especially if your income fluctuates – perhaps being self employed and having irregular income, or when you have just had a baby or plan to renovate. However beware that they can cause problems because they give you a great deal of responsibility for your own finances. If you make underpayments and take payment holidays for example, the overall amount you owe will increase. You may increase your monthly repayments or extend the term of your mortgage to compensate. Most flexible mortgages come with an initial offer period – an introductory discount, fix or cap. Lenders’ interest rates on flexible mortgages have tended to be higher than on their standard homeloans but most are now more competitive. Many non-flexible mortgages now have some flexible features such as penalty free overpayments and daily calculated interest.

Choose your repayment method

There are 3 main options for repaying a mortgage:

• Repayment Mortgage
• Interest only Mortgage
• Split interest only/Repayment Mortgage.

Repayment mortgage

This is the most common method of paying off a mortgage. Part of your monthly payment covers the interest on the loan whilst the remainder covers a small part of the capital. Over the years the overall debt decreases and therefore the interest charged on it falls as well, so more of your payments go towards paying off the debt as time passes. If you make all of your payments you are guaranteed to pay off your mortgage in full at the end of the term – which isn’t the case with interest only mortgages.

Interest only mortgage

With an interest only mortgage, your monthly repayment covers only the interest part of the mortgage, not the outstanding debt. Effectively at the end of the mortgage term you still owe what you originally borrowed. You need to make a separate payment each month into an investment vehicle to pay off the debt. You have 3 options: an endowment policy, an individual savings account (ISA) or a pension plan.

The endowment policy mortgage

An endowment policy combines a savings policy and life insurance. If you have a with profits endowment, your monthly premiums are pooled with those of other investors and invested. You are awarded annual or reversionary bonuses according to how well the investments perform and a larger terminal bonus at the end of the term. If you have a unit linked endowment, your premiums are used to purchase specific units in stock market-linked investments. The potential for growth is larger than with profits endowments but the risk is greater.

Although endowments include built in life assurance their main disadvantage is the final value may not be enough to cover your mortgage debt; you may have to increase your premiums or invest in other financial products to make up the shortfall. You can however transfer the policy to a new property if you move.

The ISA Mortgage

ISAs are a newer form of savings that are increasingly popular because all interest and bonuses generated are tax-free. As with endowment policies, you could pay off your mortgage early and generate a tax-free lump sum surplus if the ISA performs better than expected. Of course growth is not guaranteed and life assurance is not automatically included, but some financial organisations now offer all-inclusive mortgage packages.

A Pension Plan

You’re able to link your personal pension plan to your mortgage and use part of the tax free lump sum it generates at the end of the mortgage term to pay off the outstanding debt. The remainder of the sum must be used to purchase an annuity (where you hand over a lump sum in return for a guaranteed annual income until you die).

There are several disadvantages: you can only access this money when you are 50 or older, and you can only use up to 25% of the plan’s value. Pensions are tax-efficient forms of investment, however, and your money could potentially be working harder for you if you decide to buy in this way.

Split Interest Only / Repayment mortgage

Most lenders allow you to combine both repayment methods. This mainly occurs for example, if you took an endowment mortgage for your first home for £100,000 and you are looking to purchase a second home at a cost of £150,000. You may want to keep your £100,000 endowment until the policy matures, but borrow the additional £50,000 as a repayment mortgage. If you are a first time buyer you can use an existing savings policy such as an ISA to contribute towards a combination mortgage.