The different jargon and technical language of mortgages can often be enough to put people off from buying their own home, so here we’ll take a look at some of the different types of mortgages
For an introduction to mortgages, see our previous post where we explained what a mortgage is and why they’re so important.
There are several types of mortgage that you can apply for, which we have explained below:
- Repayment Mortgages
This type of mortgage is calculated so that you repay the entire debt including interest over a term of typically 25 years. When you first take out your loan you’ll be paying a large amount of interest on the debt so your monthly repayments will generally go towards covering this. However, as you continue with your repayments, they’ll start to reduce the mortgage debt more and more, and should eventually pay it off. One benefit of this type of mortgage is that you can sometimes actually decrease the length of the mortgage by paying a little extra off when you are able, this in turn reduces the amount of interest you pay in the long run.
- Interest only mortgages
With interest-only mortgages, you pay only the interest on the loan and nothing off the capital (the amount you borrowed). Your monthly repayments won’t therefore eat into any of the actual debt, which will therefore require you to have a separate plan for how to repay the original loan at the end of the mortgage term.
The main benefit of this mortgage is that the money you pay out each month is significantly lower than that of a repayment mortgage.
Having said that, these mortgages are becoming much harder to come by as lenders and regulators are worried about homeowners being left with a huge debt and no way of repaying it.
This was particularly apparent in the housing crash in the recession in 2008 & 2009 especially.
Before offering an interest-only mortgage, lenders will require proof that a reliable plan is in place to build up the funds that will eventually be required to purchase the property.
- Standard Variable Rate (SVR) Mortgages
When using this mortgage, your payments will vary in accordance with the lender’s standard variable rate, which the lender is able to change at any time. This rate is generally driven by the Bank of England’s base rate.
- Fixed Rate Mortgages
With this type of mortgage you’ll be charged a fixed rate of interest for a set term. Your repayments will remain the same even if interest rates fluctuate.
This can make budgeting easier as you’ll know exactly how much you’ll be paying each month.
However, once the fixed rate ends, usually after 2-5 years, but can be up to 10 years, you’ll be moved onto your lender’s standard variable rate, and the interest rate can then change at any time.
- Buy-to-Let Mortgages
If you are considering buying a property to let, the mortgage is one of the main things to consider. You can’t take out a standard residential loan but instead require a buy-to-let mortgage, offered by many banks and building societies.
The interest rates on buy-to-let mortgages are normally slightly higher.
The deposit required will also be more than a residential mortgage – a minimum normally being 25%, though many of the best deals are demanding over 40%.
The buy to let mortgage rates vary but are often greater than residential rates.
Most buy-to-let loans are interest only, not repayment – so only pay the interest each month and clear the capital debt when the property is sold. The monthly repayments are therefore cheaper than a repayment mortgage. However, the obvious downside is the lack of capital repayments and so the less clearing of debt
One thing that all of these mortgages have in common is the need for a deposit. A deposit displays an intention to purchase a property, but is also an indicator to the mortgage lender of the amount of risk involved in the deal.
The element of risk involved in mortgage lending is calculated using a loan-to-value ratio.
The loan-to-value (LTV) ratio refers simply to the amount of your home you own outright, compared to the amount that is secured against a mortgage. It essentially shows the level both the buyer and the lender’s equity in the property.
For example, with a £20,000 deposit on a £200,000 property, the deposit is 10% of the price of the property, and the LTV is the remaining 90%. If your loan-to-value ratio is high like this example, you’ll pose a higher risk to the lender as they’ll need to put more money on the line and the risk of you not being able to pay it back is greater.
A lower LTV is therefore safer, and is also likely to lower your interest rate. This is because the lender takes less risk with a smaller loan. The cheapest rates are typically available for people with a 40% deposit.
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