What
is a UK home loan?
A mortgage is effectively a personal loan that is obtained
from a bank or building society used to pay for a property.
The lender is then repaid in monthly instalments for a
fixed period of time. As with personal loans, mortgages
are subject to interest charges.
Types of mortgages
There are essentially two different classifications
of mortgages: repayment only mortgages and interest only
mortgages.
A repayment only mortgage requires monthly repayments
that consist of both interest charges and actual capital
repayments; effectively the same as the repayment process
for a typical personal loan. An advantage of this type
of mortgage is that lump sum payments or overpayments
can be made, which reduces the interest and capital
amounts repayable. Also, at the end of the repayment
term, the borrower is safe in the knowledge that the
mortgage has been completely repaid. There is also a
disadvantages in that the majority of repayments made
early in the repayment term consist of interest payments.
For a borrower who moves house frequently, this can
be a hindrance as little of the actual mortgage gets
repaid. Also, because it is not necessary to take out
life assurance cover with this type of mortgage, the
property will have to be sold to repay any debt that
remains in the case of death of the borrower.
An interest only mortgage requires monthly payments
that consist solely of interest payments. The capital
repayments are paid into an alternative repayment vehicle
such as a pension scheme, ISA or endowment policy; it
is this repayment vehicle that provides the lender with
the repaid capital at the end of the term. Each type
of repayment vehicle has its merits, but it is important
to choose what is right for you and for this reason,
one should seek professional financial advice.
Interest rates
When applying for a mortgage, consideration
needs to be given to the interest rate. There are four
main options: fixed rate, capped rate, discount rate
and variable rate.
• A fixed rate mortgage is when the repayable
interest remains at a fixed level for a certain length
of time, regardless of market trends. At the end of
the fixed rate period, the interest rate is converted
to the lender’s standard variable rate (SVR).
• A capped rate mortgage is when a lender caps
the repayable interest rate at a maximum level; if the
SVR drops below the capped rate, the interest payable
is based on the lower variable rate whereas if the SVR
rises above the capped rate, the interest payable is
based on the capped rate, and not the higher SVR.
• A discount rate mortgage features a variable
interest rate, but with a fixed discount for a certain
period of time e.g. a variable rate of 5% with a discount
of 2% means that the interest payable is 3%. The discount
value of 2% remains constant regardless of the variable
rate.
• A variable rate mortgage features interest rates
that are constantly varying in accordance with market
conditions.
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