MoneyMagpie Editor and financial expert Vicky Parry warns first-time buyers about the risks of not understanding the different mortgage types available
Most people need a mortgage to buy a property these days. But there are several different types – and it can be easy to compare and take what looks like the best deal only to be caught out by huge payments later on.
Understanding mortgage types is vital to making sure you’re applying for the right one for your circumstances.
Always get independent mortgage advice
Your first step in getting a mortgage should be to speak to an independent mortgage broker. This is because they will be able to search whole-market options, compared to brokers attached to high street banks or estate agents.
Some mortgage brokers do charge for their services, but there are also fee-free options available as well. An estate agent might tell you that you have to use their in-house mortgage broker, or that your house buying process will be faster if you do.
However, this is not a legal practice so do not be forced into using their broker. An independent mortgage broker will assess your whole-picture circumstances, and be able to help you find a mortgage you are likely to be accepted for.
There is nothing worse than applying for a mortgage and being denied: it can set back your house-buying plans by months or even years, as a refused application will negatively impact your credit score and make it even harder to get approved on your next application.
High loan-to-value mortgages
While these disappeared from the market for a long time following the 2008 economic crash, they’re making a comeback. Loan-to-value is the amount of money you borrow as a percentage of the property value (sale price).
The higher the loan-to-value, the lower the deposit you need to buy the house. There are now a few 95% mortgages on the market, which mean you only need 5% of the home value as a deposit.
While these seem attractive for first-time buyers, they come with big caveats. First, they don’t protect against negative equity. That means if your property drops in value over time, you are still on the hook for the full mortgage amount – and can’t raise the funds by selling your house, as the loan is higher than the property value.
This can also make it difficult to remortgage, trapping you in the property longer than you intended to live there. High LTV mortgages are also higher risk for lenders.
This means the rates are higher and terms more strict – including often being much longer mortgages, such as thirty years. The Government’s Mortgage Guarantee Scheme is designed to help mitigate this risk to attract more high LTV mortgages to the market, but you will still face higher rates as a customer.
Fixed rate mortgage
A fixed rate mortgage means the lender sets the interest rate on your mortgage. This means the monthly repayment stays the same, which means you can budget easily for your mortgage expenses.
However, if the base rate changes, you could end up paying over the odds for your mortgage. If you want to repay your mortgage earlier or make overpayments, you could face extra charges, and rates are usually higher overall than other mortgage types because the lender needs to mitigate losses over time if the base rate increases above your fixed rate percentage.
Tracker mortgage
A tracker mortgage means the interest rate is set by the Bank of England’s base rate and not the lender. This means that if the rate goes down, so does your interest – and the same if it goes up.
A tracker mortgage is a type of variable rate mortgage. You may find that some mortgages offer a fixed rate for the first few years of the term, before shifting to a variable rate.
This can help first-time buyers budget their first few years’ expenses, but puts them at risk if the base rate has significantly increased by the time their fixed term ends. It is possible to shop around for a new mortgage deal when you’re out of the fixed term, although that could come with early repayment charges, so check the fine print.
Interest only mortgages
An interest only mortgage looks very attractive to first-time buyers. That’s because, as the name implies, you’re only repaying the interest each month and not the loan value. That means you will repay far lower amounts for the duration of the mortgage.
However, there is a big caveat to this. You need to repay your full loan at the end of the mortgage term. So, while your monthly repayments might be lower, you still need to be setting aside enough money for the full loan repayment at the end of the mortgage. Interest only mortgages are high risk and only suitable if you have a solid savings plan in place.
Offset mortgages
If savings are your strength, an offset mortgage could work for you. This is where you keep your savings in a linked bank account, and only pay mortgage interest in the difference between your savings and the loan amount.
For example, if you borrow £300,000 and have £50,000 in savings, you only pay interest on £250,000. You won’t, however, earn any interest on that savings pot.
An offset mortgage means you can pay off more of the capital loan with each monthly repayment, reducing the length of your mortgage term and the overall cost of interest. However, you need to keep those savings set aside, which can make things tricky if you need an emergency fund.
Family assisted mortgage
There are two types of a family assisted mortgage available. The first, a Joint Borrower Sole Proprietor, means two people can be named on the mortgage while the property is only put into one person’s name.
This enables someone to act as a guarantor on the mortgage for someone else, agreeing to take responsibility for mortgage repayments if the named property owner is unable to repay. This requires a lot of trust and confidence in the property owner’s ability to make monthly repayments, and the person acting as guarantor should seek independent legal advice before agreeing.
Another type of family assisted mortgage is an offset mortgage using a family member’s savings. This is where your family member agrees to lock their savings into an account for a fixed term in return for the property buyer getting a 100% mortgage. The family member still earns interest (although lower than other savings options), while the buyer doesn’t need to raise a deposit as the savings act as security.
As long as all repayments are up to date at the end of the fixed term, the family member gets their savings back. The fixed term rate then ends, so repayments could go up or down for the property owner.
Mortgage limitations
Mortgages each come with different limitations and restrictions. For example, a family boost mortgage can’t be used to buy a new build or as part of the Help to Buy or Lifetime ISA property purchase scheme. Others will come with very long loan terms, or higher annual rates to mitigate risks for the lender.
Some mortgages can only be used for particular property types, such as houses and not on leasehold flats. Others will restrict the property construction type, or even require a minimum of eco-credentials (such as solar panels) on the property.
Always check the fine print, and always talk to an independent mortgage advisor before applying for a mortgage. It’s the biggest financial commitment you’ll make in your life, so it’s important to get it right by thinking about the long-term picture rather than how fast you could get on the property ladder.
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