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Understanding Mortgages

Mortgages should be a fairly simple subject - you borrow money to buy a home and then pay back the loan with interest.

If only it was that simple....

 

In a highly competitive market, banks, building societies and other mortgage lenders are constantly extending and changing their range of mortgages.

The most crucial elements to note are how you pay back the capital you borrow and how you pay the interest on it.

Paying back the capital

You can either pay a little at a time as you go, this is called a repayment mortgage. Alternatively you can pay it all off at the end, this is known as an Interest only or endowment mortgages.

Repayment mortgages - Each monthly payment pays off a little of the underlying debt, as well as interest on the loan. At the end of the term the mortgage is cleared.

 

Interest only mortgages - With this type of mortgage, you pay-off the interest on the loan but not the capital. At the end of the mortgage term you are expected to repay the capital, how you fund this is your business.

 

Interest only mortgages have grown in popularity in recent years amongst ‘buy to let’ investors and first-time buyers in particular because, put simply, they are cheaper than a repayment mortgage.

 

Paying the interest

On any debt you have to pay interest, this is no different with a mortgage. The only difference is the variety of options available.

 

Variable rates - This means you pay the going rate on your loan. The mortgage rate changes every time interest rates change or, as in most cases, the overall effect of any interest rate changes is calculated once a year and payments are changed accordingly.

Fixed rates - The interest rate is fixed for the period agreed - often two to five years.  

Incredibly low rates may tempt you, but they can be used to trap you into paying over the odds at a future date. Ensure you know how long you will have to stay with the lender before you can switch without facing a penalty.

Capped rates - These are fixed, but if rates fall you pay the lower rate. Such deals can be a good for planning your budget.