Mortgages made simple
What is a mortgage?
A mortgage is basically just a large loan used to buy a property, normally your home. The loan is secured against the property which it is buying.
Why are there so many different types of Mortgage?
The market place seems flooded with different types of mortgage, but in fact the mortgage market can be simply divided into just two types:
Capital repayment mortgages are very straightforward, when you take out a mortgage you can think of it as having two parts to pay back.
A mortgage is basically just a large loan used to buy a property, normally your home. The loan is secured against the property which it is buying.
Why are there so many different types of Mortgage?
The market place seems flooded with different types of mortgage, but in fact the mortgage market can be simply divided into just two types:
- The Capital Repayment Mortgage
- Mortgages which split the loan repayment into interest payments and then some other financial means of paying back the capital.
Capital repayment mortgages are very straightforward, when you take out a mortgage you can think of it as having two parts to pay back.
- Firstly you will need to repay all the capital cost (the actual cost of buying the house)
- Secondly you have to pay back the charge the lender makes for loaning you the money over the agreed term (the interest).
Now in a capital repayment mortgage every month your mortgage repayment that you pay back to your bank is split so that a proportion goes towards paying off the capital and the rest goes towards paying off the interest charge. The payments are worked out so that after the agreed term of making all the payments the whole debt will be repaid and you will own your home 100%.
Have a look at our mortgage calculator which will show you exactly how your interest and capital payments will be made up when you take out a mortgage.
Of course during the term of the mortgage the interest rates will vary and depending on this the interest portion of your mortgage will go up or down. The exception to this is when you have taken out a mortgage product which has fixed the interest rate for a certain length of time or taken out a capped rate mortgage where the interest rate can climb up but only until it reaches the agreed cap and then no further.
Because capital repayment mortgages are quite simple they are cheap to set up and run and generally do not have big exit penalties attached if you need to leave the mortgage.
There are lots of different flavours of this type of mortgage which allow you to fix your interest payments for a set period of time (typically 2,3,5, or 7 years) subject to extra charges at the start, there are some that track the Bank of England interest rates called Tracker mortgages and lots that offer a discounted initial low interest rate for a year or two.
Top Tip: Be careful to note that any special feature on a mortgage always increase its initial cost and usually come with tie in clauses to stop you exiting the mortgage within the promotional phase, be that a tracker interest rate or discounted interest rate mortgage.
For instance when banks offer you a fixed rate mortgage for say two years, you will have to pay what they call a booking fee at the start. The booking fee is actually the fee that the bank uses to purchase the money you want to borrow over the two years at that interest rate - they literally book the money out.
You need to be very careful about any mortgages with what look like very attractive low interest rates because you normally find that these come laden with excessive set up costs which wipe out any discount in cost you were hoping for.
Always look at the APR when comparing different mortgage products and never rely just on headline interest rates and introductory offers.
Consider carefully how much a mortgage costs to take out and really how long you think you will use it for before either moving house or changing to another product. A mortgage which is very cheap to take out and does not have any tie in period or exit charges is often the best product for most people because it offers maximum flexibility.
Do not get fooled into opting for a mortgage with a low introductory interest rate and paying many thousands of pounds to take it out only to find that had you gone for the cheap simple mortgage you could easily of hopped onto the next best deal in a few years.
Simple flexible mortgages are rarely very well promoted by banks because they offer great value for the customer and don't tie you to their services for years but make relatively little profit for the banks offering them.
The second main variety of mortgage is where the repayment is spilt so that a portion pays off the interest owing to the bank each month and then the rest is invested in some scheme with the idea that as this investment grows over the life of the mortgage it will produce a pot of money sufficient to pay off the capital (actual cost of the property). These mortgages take many forms depending on what 'scheme' is used to invest the money. Some invest into stock market funds as unit trusts (large groups of shares from many different companies hoping to spread the risk) some track the FTSE100 (name for the stock market representing the 100 biggest companies registered in the UK) some invest in pension funds etc.
This type of mortgage should never be entered into lightly, the endowment mortgage scandal of the 1980 and 1990's bears witness to the terrible mis-selling and over estimation of return that this type of product carries. There are as always exceptions and for some people for example there can be good tax efficiencies to be gained by using a mortgage product linked into their pension. However as a general rule I would recommend you steer well clear of this market. It is still riddled with problems and has the fundamental flaw that the investment part of these mortgages have to be 'managed' by the bank for which there are always substantial charges which go a long way to eroding many of the possible investment gains.
Because these mortgages are complex they are costly to set up and run and usually not that simple to exit early if you have too.
Think of them as a form of gambling and ask yourself whether you want to use gamble with your home? Of course banks and financial advisor’s love them, but again ask yourself why? Because they make a lot of money from running them ie. from you.
There is a third type of mortgage which is no longer widely available because of the serious problems it caused during the housing bubble of the 2008-2009 which is the interest only mortgage. This is much as the name suggests, a product with which you only ever pay off the interest owing to the bank and never any capital. By the end of the mortgage term the bank still owns your house and you have to of had some alternative way of saving up the capital to buy your home. It was very popular with buy to let investors and property developers who intended to only hold onto to a property for a short period of time while renovating it and then selling it on for a profit. It worked well in a rising housing market but is disastrous in a stagnant or falling market and in inexperienced hands. We would advise you to steer well clear.
SimplifyLoans mortgage tips:
1. The best mortgage will normally be the simplest mortgage product.
2. Look for mortgages with no or only small set up costs and no tie in periods and exit charges
3. Capital Repayment mortgages are the safest and often cheapest way to take out a mortgage
4. Always use the APR to compare deals – the headline interest rate is of no use and will only confuse you
5. Mortgage products which are heavily promoted by banks are usually the ones which make them the most money and therefore cost you more.
Have a look at our mortgage calculator which will show you exactly how your interest and capital payments will be made up when you take out a mortgage.
Of course during the term of the mortgage the interest rates will vary and depending on this the interest portion of your mortgage will go up or down. The exception to this is when you have taken out a mortgage product which has fixed the interest rate for a certain length of time or taken out a capped rate mortgage where the interest rate can climb up but only until it reaches the agreed cap and then no further.
Because capital repayment mortgages are quite simple they are cheap to set up and run and generally do not have big exit penalties attached if you need to leave the mortgage.
There are lots of different flavours of this type of mortgage which allow you to fix your interest payments for a set period of time (typically 2,3,5, or 7 years) subject to extra charges at the start, there are some that track the Bank of England interest rates called Tracker mortgages and lots that offer a discounted initial low interest rate for a year or two.
Top Tip: Be careful to note that any special feature on a mortgage always increase its initial cost and usually come with tie in clauses to stop you exiting the mortgage within the promotional phase, be that a tracker interest rate or discounted interest rate mortgage.
For instance when banks offer you a fixed rate mortgage for say two years, you will have to pay what they call a booking fee at the start. The booking fee is actually the fee that the bank uses to purchase the money you want to borrow over the two years at that interest rate - they literally book the money out.
You need to be very careful about any mortgages with what look like very attractive low interest rates because you normally find that these come laden with excessive set up costs which wipe out any discount in cost you were hoping for.
Always look at the APR when comparing different mortgage products and never rely just on headline interest rates and introductory offers.
Consider carefully how much a mortgage costs to take out and really how long you think you will use it for before either moving house or changing to another product. A mortgage which is very cheap to take out and does not have any tie in period or exit charges is often the best product for most people because it offers maximum flexibility.
Do not get fooled into opting for a mortgage with a low introductory interest rate and paying many thousands of pounds to take it out only to find that had you gone for the cheap simple mortgage you could easily of hopped onto the next best deal in a few years.
Simple flexible mortgages are rarely very well promoted by banks because they offer great value for the customer and don't tie you to their services for years but make relatively little profit for the banks offering them.
The second main variety of mortgage is where the repayment is spilt so that a portion pays off the interest owing to the bank each month and then the rest is invested in some scheme with the idea that as this investment grows over the life of the mortgage it will produce a pot of money sufficient to pay off the capital (actual cost of the property). These mortgages take many forms depending on what 'scheme' is used to invest the money. Some invest into stock market funds as unit trusts (large groups of shares from many different companies hoping to spread the risk) some track the FTSE100 (name for the stock market representing the 100 biggest companies registered in the UK) some invest in pension funds etc.
This type of mortgage should never be entered into lightly, the endowment mortgage scandal of the 1980 and 1990's bears witness to the terrible mis-selling and over estimation of return that this type of product carries. There are as always exceptions and for some people for example there can be good tax efficiencies to be gained by using a mortgage product linked into their pension. However as a general rule I would recommend you steer well clear of this market. It is still riddled with problems and has the fundamental flaw that the investment part of these mortgages have to be 'managed' by the bank for which there are always substantial charges which go a long way to eroding many of the possible investment gains.
Because these mortgages are complex they are costly to set up and run and usually not that simple to exit early if you have too.
Think of them as a form of gambling and ask yourself whether you want to use gamble with your home? Of course banks and financial advisor’s love them, but again ask yourself why? Because they make a lot of money from running them ie. from you.
There is a third type of mortgage which is no longer widely available because of the serious problems it caused during the housing bubble of the 2008-2009 which is the interest only mortgage. This is much as the name suggests, a product with which you only ever pay off the interest owing to the bank and never any capital. By the end of the mortgage term the bank still owns your house and you have to of had some alternative way of saving up the capital to buy your home. It was very popular with buy to let investors and property developers who intended to only hold onto to a property for a short period of time while renovating it and then selling it on for a profit. It worked well in a rising housing market but is disastrous in a stagnant or falling market and in inexperienced hands. We would advise you to steer well clear.
SimplifyLoans mortgage tips:
1. The best mortgage will normally be the simplest mortgage product.
2. Look for mortgages with no or only small set up costs and no tie in periods and exit charges
3. Capital Repayment mortgages are the safest and often cheapest way to take out a mortgage
4. Always use the APR to compare deals – the headline interest rate is of no use and will only confuse you
5. Mortgage products which are heavily promoted by banks are usually the ones which make them the most money and therefore cost you more.