Mortgages

Mortgages and other costs of buying a home

Buying a property, particularly your first property, usually involves taking out a mortgage – a loan secured against the home.

To guide you through what can seem like a maze of mortgages, here’s personal finance expert Jonquil to explain the six most common types: fixed rate mortgage, variable rate mortgage, capped rate mortgage, offset mortgage, flexible mortgage, shared ownership mortgage.

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JONQUIL

If your budget will be a bit tight at first, one option is to look at a fixed rate mortgage. The interest rate is 'fixed' for the first two, three, even five years. The advantage of that is you know exactly what you'll be paying each month for the mortgage. You're protected from any interest rate rise. Some countries have mortgages fixed for long periods like 10 or 25 years, but although there are a few like that here in the UK, they've never really caught on.

Remember, you'd be locked into the same rate year after year. If other interest rates fall, you'd be paying over the odds, so a fixed rate that seems like a good deal at the start can become uncompetitive. Fixed rate mortgages usually have early redemption penalties. These are fees, payable for repaying the mortgage early.

So you would need to weigh up what you'd lose in charges against what you would gain in switching. And you do have to repay the mortgage and then take out another, so it may mean negotiating all over again, even if you stay with the same Bank or Building Society.

The opposite of a fixed rate is a variable rate mortgage, where the interest rate - and so your monthly payments - can go up and down. But, again if you're worried about your budget in the early years, you could go for a discounted rate mortgage. In other countries they sometimes call this the "low start" mortgage. Your interest rate and repayments start at a special low rate. The interest rate then goes up to the lender's full rate - called its 'standard variable rate - so you need to make sure you will be able to afford the increased payments. You could look around then to see if you can switch to another low-cost deal.

But discounted rate mortgages usually have early repayment charges that extend beyond the discount period, so - once again - you'd have to weigh those up against the gain from switching. You could opt for a 'capped rate' mortgage. That's a mortgage where the interest rate is variable, but can't exceed a maximum level and so you know your monthly repayments will never go above a certain amount. Like the other special mortgage deals, these are also likely to have early redemption penalties. An alternative product is a collared rate mortgage where there is both a cap on how high the rate can go and a floor below which the mortgage rate cannot fall. These, though, are uncommon in the UK mortgage market.

Offset mortgages are interesting. If you have surplus cash - say in your current account or your savings account - you can move that to the mortgage lender and its deducted from the amount you owe on your mortgage before the monthly mortgage interest is worked out. So if the interest rate received on the savings account is lower than that charged on the mortgage - which typically it is - this can be a good deal. In effect, your savings are earning interest at the mortgage rate. Usually, you can still draw your savings out - for example for a holiday or life's uncertainties - then of course, the interest charged on the mortgage goes up.

The interest rate on an offset mortgage is usually a bit higher than other lenders would charge. Whether it's a good deal really depends on the amount of savings you can offset. You might want to consider a flexible mortgage. A variable rate mortgage where you can choose to vary your monthly payments and sometimes borrow back money you've already paid off. Obviously being able to reduce your payments could be useful if you're going through a tough time financially. But flexibility is good the other way too.

Most mortgages these days let you pay off extra if you want to. That means you pay off your mortgage faster and pay less interest in total. However some people worry that, with the freedom to reduce payments in bad times, they won't push their payments back up enough in the good times. Like when you're on holiday, you don???t want to go back to work. With a fixed or variable rate mortgage, you pay whatever the lender tells you to pay each month - and that inflexibility is sometimes helpful, if you want to be disciplined about repaying.

Shared ownership schemes are becoming more available - they're often aimed at first-time buyers who can't pay a big deposit, or easily afford the payments on a full mortgage. The idea is that you partly buy and partly rent your house.

For example, you might buy 75%, and take out a mortgage on that. Then you pay rent on the other 25%. You still have to pay a deposit on the share that you're buying - but it can work out cheaper per month than buying the house entirely. And when you can afford more repayments, you can increase the share you're buying. For shared ownership you have to buy a house or flat from a housing association, or sometimes a property developer. That often means it'll be a new-build property, especially if you choose one of the special schemes backed by the government. The housing association sometimes has first-call on the property if you want to sell it. And not all banks and building societies will lend for shared ownership - but most do.

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As with all debt you should only borrow what you can afford to repay. Look at how much repayments would be now, and consider whether you could continue to repay it were interest rates to rise.

Getting a mortgage almost always requires a sizeable deposit as well. Bigger deposits tend to give better interest rates, and most banks won’t lend to you unless you have at least a 5% or 10% deposit.

In addition to the deposit there are several costs involved in buying a house. Sometimes these can be added onto the mortgage, though sometimes banks expect these to be covered by the deposit. To show you how these costs may add up, let’s suppose you’re buying a property for £200,000. What costs do you incur?

• Mortgage arrangement fee (common with fixed rate, capped and discounted mortgages): say, £500.
• Legal costs including local searches and Land Registry fee: £800.
• Survey and valuation: £350.
• Stamp Duty Land Tax: £2000. (In 2014/15 this was charged on an increasing scale: 0% on property purchases up to £125,000; 1% above £125,000; 3% above £250,000; and higher rates above that. The relevant rate applies to the total purchase price.) In Scotland the equivalent to SDLT is Land and Buildings Transaction Tax.
• Removal costs: say, £700.

GRAND TOTAL: £4350.

There may also be a fee to the mortgage broker if you’ve used one to help choose and organise the mortgage. But more often the broker is paid by commission from the mortgage provider and this is ultimately borne by the borrower through charges for the mortgage.

Buying a property is a big undertaking, for most people the most expensive thing they ever buy, and we cannot cover all the necessary details here. Estate agents or property lawyers may talk you through the process, but it may be worth getting professional advice before going ahead.