Mortgages
A mortgage is simply a loan which is secured against a property. Typically, a house purchase is an individuals largest commitment in their lifetime and one of the only ways to facilitate this is to arrange a mortgage to provide the funds to buy the property. As long as the regular mortgage payments are met, at the end of the mortgage term the individual will own the home plus any growth in the value of the property too. One of the main benefits of mortgages is that it gives someone control over a property without paying for it upfront, in addition to this, mortgages are seen as a very good hedge against inflation because the value of the debt will reduce in “real terms” over the long term.
Usually, the company which has provided the funds will hold the title deeds for the property and if the repayment obligations cannot be met, the lender has the right to force a sale on the property in order for them to retrieve as much as the original capital as possible. At first there was a very limited amount of mortgages available from a select number of lenders, however, after increased competition there are over a hundred different products available. Here is a snapshot of the most popular types of mortgages explained:
Capital & Interest repayment mortgage
The most common type of mortgage, repayments are split into two elements. one is the capital repayment part. Here, the payments will reduce the outstanding debt which will result in less future interest payments. The interest element pays only the interest due on the size of the current loan. For example, on a debt of £100,000 at a repayment rate of 5%. at the start of the mortgage £4,000 may pay off the interest part of the loan and £1,000 may be used to pay the capital repayment element. Towards the end of the payment term, these value proportions may be reversed.
Interest only mortgage
With an interest only mortgage, the repayments made are only directed to paying the current interest charged and do not pay off any of the original capital. In theory, the mortgage could continue forever. This is considered a high risk option but the main advantage is short term cost savings, The repayments are generally 30% cheaper than capital & interest repayment mortgages. The main disadvantage is that the debt does not reduce. Many buy to let mortgages are arranged on this basis where the rental income covers the mortgage repayments and the landlord will profit from any differential in the rent and mortgage payment plus any growth on the value of the house.
Endowment Mortgages
This type of mortgage consists of an investment linked monthly savings plan with life assurance attached over a long term. In theory, at the end of the term, the value of the savings element was calculated to match the outstanding value of the mortgage debt, however in reality this was not the case. Poor investment returns in late 1990′s and early 2000 meant that many customers had substantial shortfalls on the value of their endowments and subsequently, huge mis-selling claims were lodged and compensation payments are still being issued now. Many of these plans are still yet to mature.
Offset mortgage
An offset mortgage provides the facility to convert some or all of your savings into a mortgage account. The main advantage is flexibility and in most circumstances you can pay a reduced amount of interest. For example, if your receive 3% (Gross) interest on savings and pay 5% interest on mortgage repayments, then there is immediate saving of 2% per year. This option is especially useful for higher rate taxpayer, who will receive interest of 1.8% (net) on interest @3% thereby saving 3.2% per year. Some people use these accounts almost like a large overdraft because there is still access to the funds.
Due to the large number of repossessions after the effects of the credit crunch, many lenders have withdrawn their most competitive rates and will only lend to people who have excellent credit ratings and are willing to place a sizeable deposit on the property first. That is why speaking to a professional first is essential in assessing your options.
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