Interest-only or Repayment Mortgage
Mortgage jargon stripped down
First things first:
A 'mortgage' is a loan secured against your home.'Secured' means that if you do not keep up the payments the lender can sell your home to get its money back.'APR (Annual Percentage Rate)' takes into account the interest on the loan and other charges. All lenders have to tell you what their APR is and you can use it to compare loan offers. Remember: your home may be repossessed if you do not keep up repayments on your mortgage.
In this section we also cover:
Repayment or interest-only mortgage?What sort of interest rate arrangement?Standard rate variable mortgageFixed interest rate mortgageCapped rate mortgageCollared rate mortgage (END LIST)
First decision - repayment or interest-only mortgage?
Repayment mortgage (also called a capital and interest loan)
Your monthly payments gradually pay off the amount you have borrowed as well as the interest charged on the loan. Provided you make all the agreed payments, the loan will be fully paid off by the end of the mortgage term.Could this be right for you? Consider whether you want the security that, provided you keep up with the payments, your mortgage will be paid off at the end of the mortgage term.
Interest-only mortgage
With this type of mortgage your monthly payments only cover the interest on the loan. They do not pay off any of the money you have borrowed (the capital). You will need to arrange an alternative way to pay off the capital at the end of the mortgage term, for example by paying money into a savings or investment plan.It is your responsibility to make sure you have enough money to repay the mortgage at the end of the term, otherwise you could lose your home.Could this be right for you? Consider whether you're comfortable with the risk that you may not be able to pay off the full loan at the end of the mortgage term.
Second decision - what sort of interest rate arrangement?
Whether you choose a repayment or an interest-only mortgage, you will also need to consider the different interest rate options that are available. Here is quick explanation of the various options and some pointers to think about. Bear in mind that what looks like a cheaper mortgage today may not prove to be so in the long run. Make sure you know what happens after any special deal ends.
Standard variable rate mortgage
Your monthly payments will go up or down when the lender's mortgage rate changes. Mortgage rates tend to move in line with the Bank of England base rate, which is reviewed monthly.
A tracker mortgage is a type of variable interest rate mortgage.
With a tracker mortgage the interest rate is a set amount above or below the Bank of England or some other base rate. It always 'tracks' changes in that rate.
A discounted interest rate mortgage is another type of variable interest rate mortgage.
In this case your payments are variable, but they are fixed at less than the lender's standard variable rate for a set period of time. At the end of this period, you are usually charged the lender's standard variable rate.
With cashback.
You receive a sum (usually between 3-6% of the amount borrowed) shortly after you take up the loan. You will normally have to repay some or all of the cashback if you repay the mortgage in the early years.
Potential upsides and downsides of a variable rate mortgage:
Upsides:You benefit from any decreases in interest rates with the result that your monthly payments may go down. You will usually have the flexibility to make overpayments without penalty (assuming there are no restrictions on making such payments and no early repayment charges apply). Downsides:If interest rates rise, your monthly payments go up. With a discounted mortgage, remember to think about what your monthly payments will be at the end of the discounted period, including potential increases in interest rates.
Fixed interest rate (limited period) mortgage
Your payments are fixed at a certain level for a set period of time, for example two, five or ten years and maybe even longer. Unless the rate is fixed for the term of the mortgage, you are usually charged the lender's standard variable rate at the end of the fixed rate period.
Potential upsides and downsides of a fixed rate mortgage:
Upsides:You know exactly how much your monthly payments will be for a specified period which can help you budget. You are not affected by Bank of England interest rate rises for the period of the fix. Downsides:If interest rates fall, your payments will still stay the same - they won't go down. You may not be able to make overpayments and there may be a charge for repaying the mortgage early.
Capped rate mortgage
The interest rate for this type of mortgage is variable and often linked to a base rate, such as the Bank of England base rate. Your monthly payments will go up and down according to changes in the specified base rate. However, the interest rate will not rise above a set level (the 'ceiling' or 'cap') during the period of the deal. At the end of the period, you are usually charged the lender's standard variable rate.
Potential upsides and downsides of a capped rate mortgage:
Upsides:You know the maximum your monthly payments will be over a set period, even if interest rates rise above this rate. You will also benefit from any decreases in interest rates which means that your monthly payments may go down. Downsides:If interest rates rise, your monthly payments will increase - but not beyond the capped rate. This can make it more difficult to budget ahead than, for example, with a fixed rate mortgage.
Collared rate mortgage
This arrangement can be used in conjunction with a capped rate and/or a variable rate tracker mortgage. Your payments are variable but will not fall below a set level (the 'collar' or 'floor').A collared rate may be part of another interest rate deal which otherwise appears attractive.The thing to remember with a collared rate mortgage is that if interest rates fall, you may not get the full benefit of a reduced payment as you would with a wholly variable rate mortgage.
