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When it comes to choosing your next mortgage, it pays to engage your inner-strategist. We take you through the different elements of a home loan to help you secure the best deal for you.
Mortgage repayment options
As its name suggests, under an interest-only mortgage, borrowers only pay interest on their mortgage, they do not repay the debt itself. Borrowers only pay back the debt at the end of the mortgage term.
Lenders are generally now less willing to offer interest-only mortgages than they were in the past, and borrowers who take one out must be able to demonstrate that they have a credible repayment plan.
Interest-only mortgages are also considered to be higher risk, and, as a result, banks and building societies tend to have stricter affordability criteria for them, and will often only lend to people who have a large equity stake in their home, meaning first-time buyers may find it more difficult to take one out.
That said, interest-only deals do still have some advantages. The main one is cost, with monthly repayments on a £200,000 interest-only mortgage at 2.5% over a 25-year term coming in at £417, compared with £905 for a repayment mortgage.
As a result, people may feel an interest-only mortgage is a good choice if it enables them to buy a more expensive property, as repayments would be lower. However, borrowers would need to feel confident they will still be able to repay the outstanding debt at the end of the term.
A repayment mortgage allows you to repay a bit of the loan along with interest each month.
The main advantage of a repayment mortgage is that, as long as you keep up with your payments, you will own your home outright at the end of your mortgage term.
As a result, you don't have to worry that your savings or investment plan is on track in the way you do with an interest-only mortgage.
Another benefit is that you will be increasing the equity stake you have in your property as you gradually reduce the amount you owe.
As a general rule, homeowners with larger equity stakes can qualify for lower mortgage rates, with the best interest rates typically reserved for those who are borrowing 60% or less of their property's value.
You are also likely to have greater choice of mortgage products if you are on a repayment mortgage, as not all mortgages are available to people on interest-only loans.
Under an offset mortgage, you place your savings with the same institution with which you have your home loan. And instead of being paid interest on your savings, the balances are used to offset the amount of money you owe on your mortgage, reducing the amount of interest that you pay.
The advantage of an offset mortgage is that it enables you to use your savings to reduce the interest you pay each month, reducing your mortgage term, while still enabling you to access the money if you need it.
For example, if you had a £200,000 mortgage, at an interest rate of 2.5% over a term of 25 years, and £50,000 in savings, you could repay your mortgage three years and three months early, saving yourself £10,365 in interest.
Offset mortgages work best for people who have already accumulated significant savings.
Homeowners who do not have a substantial nest egg may be better off opting for the lowest mortgage rate they can find and the highest return on their savings.
Broadly-speaking, there are two main types of mortgage, fixed rate mortgages and tracker mortgages.
If you take out a fixed rate mortgage, the interest rate you pay is fixed for the term of the deal, typically two or five years, although some longer fixed rate mortgages are available.
By contrast, tracker rate mortgages move up and down in line with changes to the Bank of England base rate.
Both types of mortgage have pros and cons, so it is important to take the time to think about which one will best suit your circumstances.
The advantage of fixed rate mortgages is that you know exactly what your repayments will be each month.
The downside is that if you want to end the mortgage before the term is over, you are likely to face early redemption penalties, which could be as high as 5% of the sum you borrowed. It is also worth noting that not all fixed rate mortgages allow you to make overpayments.
Tracker mortgages don’t come with the same certainty for monthly repayments as fixed rate ones, but they do tend to be more flexible, allowing regular or ad hoc overpayments and they often have no or only small early redemption penalties.
Another factor to bear in mind when selecting which mortgage type to go for is whether or not interest rates are expected to fall or start increasing.
For example, with the Bank of England base rate currently at a record low of 0.1%, it is highly unlikely that people with a tracker mortgage will benefit from further reductions.
That said, if interest rates on fixed rate deals are significantly higher than those on trackers and you have plenty of slack in your budget to be able to afford a rise in interest rates, it might still be worth opting for a tracker mortgage.
Other factors to consider
Traditionally, mortgage terms used to be 25 years long, but things have changed, and you can now stretch your repayments over 35 years, or in some cases even longer. You also have the option of repaying your loan over a shorter period, such as 15 years.
Both longer and shorter mortgage terms have advantages, so it is important to weigh up the benefits.
The biggest pro of opting for a short term is that it enables you to be mortgage-free quicker, saving you a considerable sum in interest. For example, if you borrowed £200,000 at a rate of 2.5%, you would only pay £40,064 in interest if you cleared your loan in 15 years, compared with £69,204 if it took you the standard 25 years.
But longer mortgage terms have advantages too. Repaying your home loan over a longer period of 30 years, for example, reduces your monthly repayments from £905 to £720 under the above scenario.
Having lower monthly repayments may enable you to afford to buy a more expensive property than would otherwise have been the case, and while you will pay more in interest over the life of your mortgage, you could save a considerable sum in buying and selling costs if it enables you to miss out a rung of the property ladder.
Alongside deciding the length of your mortgage term, you should also pay attention to the length of a particular deal.
For fixed rate mortgages, deal lengths are typically two years, five years or 10 years.
The advantages of opting for a longer deal term is that it gives you the security of knowing what your monthly repayments will be for longer, while you will also save month on mortgage arrangement fees if you do not need to remortgage as frequently.
With interest rates currently at a record low, opting for a five or 10-year deal gives you longer to enjoy the current low-interest rate environment.
The downside of longer fixed rate deal terms is that the longer the deal is for, the higher the early redemption penalties tend to be if you need to exit it early on.
Penalties are typically calculated as 1% of the outstanding mortgage debt multiplied by the number of years left on the deal term. So, if you exit a five-year deal in the first year, you will be charged 5% of the outstanding sum, while charges on 10-year mortgages start at around 7% in the first three years.
As a result, it pays to have a good think about whether you are likely to need to move home during the deal term, or what you would do if you lost your job.
Tracker mortgages typically have deal terms of two years, although deals are also available over three years, five years, 10 years and the lifetime of your mortgage.
Unlike fixed rate mortgages, they do not tend to have hefty early redemption penalties, although some will charge a small administration fee. The decision about how long a deal you should go for will be more influenced by how good you think the rate is, as well as the size of the arrangement fee you have to pay.
When thinking strategically about your mortgage, another factor to consider is whether to make overpayments on your loan.
Some mortgages enable you to pay extra on your monthly repayments to help reduce your overall mortgage term, while others let you contribute one-off lump sums annually or on an ad hoc basis.
Making even small overpayments each month can have a big impact. For example, on a £200,000 mortgage at 2.5%, overpaying by £50 a month would reduce your mortgage term by one year and nine months, while overpaying by £100 would reduce it by three years and four months.
Making a one-off annual payment of £1,000 would reduce your mortgage term by two years and nine months under the above scenario, while making one of £2,000 would reduce it by a massive five years.
Even so, it is still worth taking the time to be sure you can afford to make overpayments, as while some lenders allow people who have overpaid to take payment holidays if they need to, others do not, so it is worth building up some savings first.
How to apply
Use a broker or go direct
Not only do you need to think about the type of mortgage you want, but you should also consider whether to apply for it directly with the lender or use a mortgage broker to help you.
If your application is relatively straightforward, for example, you have a lot of equity in your property and can easily afford monthly repayments, you are likely to be fine applying directly to the lender, particularly if you have applied for a mortgage before and are confident you can locate a good deal without assistance.
Mortgage brokers really come into their own for people with less straightforward circumstances, such as those with only small deposits or who need to borrow a high multiple of their income.
They can also be helpful if you are a first-time buyer and are not familiar with the mortgage application process, or you feel you do not have a good enough understanding of the market to navigate it on your own.
The advantage of using a broker is that they will be able to scour the mortgage market to locate the best deal for your circumstances. They may even have access to exclusive rates that are only available through brokers.
The downside is that you may need to pay a fee for their services, making your mortgage application more expensive. That said, some brokers are paid through commission they receive from mortgage lenders.
Online lenders and brokers versus traditional players
A number of online mortgage lenders and brokers have entered the mortgage market in recent years.
Lenders such as Digital Mortgages and buy-to-let specialist Molo, and brokers such as Trussle and Habito, offer a fully online service, with no physical branches.
New online-only lenders offer a fast service, and they also generally enable you to get a status update on your application at any time through the internet.
The experience of using a digital-only lender might not be for you if you are not very technology-savvy or don’t own a smart phone, and prefer the reassurance of having a physical branch you can go to if you need to.