My First Post: What is a Mortgage?

Writing this has helped me gain an basic understanding of what mortgages are, and hopefully as I gain more knowledge on the subject I can post updates which will go into more detail.

So, a mortgage is really just a loan, but with two special characteristics.
Firstly, it is designed to be paid back with interest over a long period, typically 25 years. Secondly, unlike a standard bank loan a mortgage is “secured”. In return for lending you the money, the bank will use the property as security for the mortgage, so if for some reason you can’t make the repayments, the lender has the right to reclaim your house and sell it to recoup the money you borrowed.

The way I understand it, there are a couple of choices that must be made which will enable you to more easily navigate your way through the thousands of mortgages available, and be left with the mortgage which is right for you.

Here is a brief breakdown of those choices, and hopefully as my understanding grows I’ll be able to provide a more detailed guide on each in later posts:

Choice 1: Interest only or Repayment?

At its most extreme, on an interest only mortgage, and after 25 years of monthly payments on a £100,000 loan, you would still owe £100,000. However, if you’d had a repayment mortgage, whilst it would have cost more each month, it would have cleared the interest and the loan, meaning you’d owe nothing at the end.

Choice 2: What type of Mortgage?

Standard Variable Rate (SVR)
This roughly follows the Bank of England interest (base) rate, but generally floats just above it. Whilst it can be considered the most easily understandable mortgage, it is certainly not the cheapest.

Tracker
A tracker follows the Bank of England base rate absolutely, so you benefit from all rate drops, but take the brunt of all rate rises aswell. Most usually offer a ‘collar’ of say 2.5%, which would protect you from huge increases but then also prevent large decreases.

Discount
Now things are getting more complicated. Whilst a discount mortgage sounds great, you’ll have to know both how big the discount is and what it’s off. Usually it is a fixed term discount off the SVR as above, so once the discount wears off you may be stuck on the more expensive SVR mortgages. You would need to work out whether the initial discount will outweigh the potential extra costs long term, and I can’t see how that would be a simple task.

Fixed
With a fixed mortgage, your repayments are guaranteed to be the same each month for as long as the deal lasts. This will usually be 3 to 5 years, although longer term deals are sometimes available. However, this is a service you will pay for, and you would often be better off on a Discount Mortgage as above.

Capped
Part Variable rate, part Fixed. The rate you pay tracks the base rate but there is a “cap” in place which offers protection from large rate increases. Just as a collar sets a minimum. Given that the Bank of England base rate has recently plummeted, this looks to be an attractive mortgage. However, the cap may be set fairly high, in which case if you were gambling on the interest rates suddenly rising again, the Fixed mortgage above would probably be the better option!

Cashback
This does exactly what it says on the tin, and whilst a lump sum payment of around 5% of your total loan would be nice, nothing in life is free. You’ll need to look at all aspects of this type of mortgage carefully to see where they are getting the money back. i.e. higher interest rates or hefty early repayment charges.