What is a mortgage?
Mortgages are essentially loans which are secured against a home, property or land. Typically, most people take out a mortgage for the purpose of buying their home.
As part of the mortgage agreement, the borrower is contractually obliged to repay the loan amount plus any interest charged by the lender. This usually happens through monthly repayments which are structured to reflect the type of mortgage product used and the rate of interest charged by the lender.
Whilst the borrower repays the loan the lender retains a charge (or security) over the property. This means that if the borrower fails to make continuous repayments the lender can repossess the property.
Types of repayment models
With most mortgages available today, there are broadly two types of repayment options for the borrower:
• Repayment mortgages - this is sometimes also known as 'capital-and-interest mortgages'. As the name suggests, with this type of mortgage the borrower makes monthly repayments to the lender which includes an element of the capital (i.e. the initial loan amount) and also the interest. The proportion between capital and interest will vary over the term of mortgage. Over time as more capital is repaid, the interest element decreases. At the end of the mortgage term, if all repayments have been made, the mortgage will be repaid and the borrower owns the property outright.
• Interest only mortgages - with this type of mortgage, the monthly repayments comprise of only the interest and does not include any repayment towards the original loan amount. The borrower is still responsible for repaying the full loan amount at the end of the mortgage term. There are, therefore, some additional risks with this type of mortgage in that the borrower may not have sufficient funds to repay the full loan amount at the end of the term. To help the borrower avoid this scenario, it is very important that the borrower has a suitable repayment vehicle in place to repay the capital at the end of the term.
Mortgage interest options
Regardless of the repayment model the borrower opts for, they will have a further choice as to the type of mortgage product they have. There are several options aimed at helping borrowers with different needs.
• Fixed rate - the borrower is able to enjoy a fixed interest rate for a specified period. Though usually between 1-5 years, it can be for longer. The main advantage of this is that monthly repayments are 'fixed' for the duration of that period helping the homeowner budget effectively. This is usually of particular benefit to first time buyers or those on tight budgets.
• Variable rate (or standard variable rate) - here payments can move up or down depending on changes to the rate of interest being charged by the lender. Though there may be changes in the Bank of England's Bank Rate, individual lenders will decide how they set interest rates for their own products.
• Tracker rate - this is a variable rate loan with an interest rate that tracks movements in the Bank Rate set by the Bank of England. The lender will set the interest rate initially, and this can be set to be equal, above or below the Bank Rate. The rate then tracks (i.e moves up or down with) the changes to the Bank Rate.
• Discounted mortgage - the borrower gets a discount off the lender's standard variable rate usually for a specified time period. This type of interest option can be good for those who know they will have a tight budget in the immediate term and are confident that they will be able to increase their payments when the discounted period comes to an end.
• 'Capped' and/or 'collared' rates - these are variable rates but with limits. For example, the lender may not be able to increase their rate above a certain amount ('cap'); or reduce it below a certain floor ('collar').
Mortgage features and products
There are many additional features that lenders may offer on a mortgage, such as an offset; flexible or cashback mortgages. You should contact the building society directly, or speak to an independent mortgage adviser, to see what is most suitable for your needs.
If you have a mortgage, but are having trouble making your repayments, take a look at this factsheet.