Basic principles of mortgaging (the UK)
Ordinary people who want to get a loan think that mortgages are quite understandable - you borrow money to buy a house and pay interest on the loan. But after a couple enquiries they realize that it’s not that simple at all. In a rough competitive market, building societies and banks are continually extending their range of mortgages. The UK government deals with mortgaging problem to helps people get the right mortgage understanding. The most important points are how you pay back the money you borrow and how you pay the interest on it. You can either pay a little at a time as you go (repayment mortgage) or pay it all off at the end (Endowment, ISA and pension mortgages).
Repayment mortgages are monthly payments of the underlying debt, as well as interest on the loan. At the end of the term the mortgage is cleared.
Endowment Mortgages are used to provide life insurance and save funds to repay the loan at the end of the term (usually 20-25 years). If the investment performs poorly, you could face a shortfall on your loan at the end of the repayment period.
Individual Savings Account (ISA) mortgages work on the same principle as endowments, but use an Individual Savings Account as the loan repayment method. If your investment performs badly you could face a shortfall at the end of the mortgage term.
Pension mortgages are similar to both ISA and endowment mortgages, but work on the basis that pensions provide tax-free cash on retirement. At the end of the mortgage term the loan is paid out of your tax-free lump sum. They are not often used as it can be risky linking pensions to other investments.
The main rule for any debt or mortgage is paying interest rate. There are different kinds of interest rates:
Variable rates are the rates that changes every time. Or in most cases the overall effect of any interest rate changes is calculated once a year and payments are altered accordingly. Whatever kind of mortgage you start with, it is likely to change to variable rates at some point.
Fixed rates are fixed for the period agreed (2-5 years). These are ideal for budgeting or if you think rates might increase. You do not benefit if rates fall and will face penalties if you try to quit. Just remember that very low rates may tempt you, but they can be used to trap you into paying over the odds. Capped rates are fixed, but if rates fall you pay the lower rate. Such deals can be a good option for budgeting. Cash back deals mean that lenders offer money back if you take out a particular product. Discounted rates enable discounts off the lender’s variable rate to the borrower.
The UK government suggests buyers a list of questions to ask before agreeing a mortgage with a lender. This can help you to make up your mind and choose the right mortgage program.
- How much can I afford to borrow?
- What will the cost be each month? What fees will I have to pay?
- How can I tell which mortgage rate is best for me?
- What is the best type of mortgage for me?
- How should I repay the mortgage?
- Why are you trying to sell me an endowment policy, or a pension or an ISA?
- Will this mortgage suit my situation today and in future?
- What commission are you being paid?
- Can I make lump sum payments to reduce the size of the loan?
- Are there any redemption penalties?
- Does this mortgage come with obligatory insurance?
- What are the other charges I’ll have to pay?
- What may happen if can’t pay?