How do mortgages work? (+3 Key tips)
What are mortgages?
Mortgages are loans which you take out so you can purchase a home. Mortgages work by charging you interest on the amount you want to borrow over a set period of time.
Mortgages can be used for 25, 30 years and even more when you consider reverse mortgages and lifetime mortgages.
What are the cheapest type of mortgage
Mortgages come with several charges but the highest charges will likely be the interest you repay over the term of the mortgage. Mortgages work for the lender by them charging you interest which you repay over the lifetime of the mortgage.
How does mortgage interest work?
The most important factor guiding how your mortgage interest works is the bank of England base rate. If this goes up or down, it is very likely your mortgage interest rate will do the same if you are on any rate other than a fixed rate.
If interest rates stay the same:
A variable or tracker rate mortgage may usually be the best mortgage to be on if you want to benefit from any drop in interest rates.
Fixed rate mortgages are known to have slightly higher interest rates as they offer certainty over a given timeframe but whether they will be cheaper than the current variable rates will depend on too many economic factors. In most cases, they may be slightly higher than the current variable rate mortgage.
If interest rates go up:
A fixed rate or capped rate mortgage may be the best while a standard variable rate mortgage or tracker rate mortgage will likely follow the England base rate.
This means your monthly mortgage repayments will likely go up.
Mortgages don’t exactly work like this as most mortgage lenders will still need to make the economic decision on if to increase the rates on their mortgage as interest rates have risen.
If interest rates go down:
If interest rates go down then a fixed rate mortgage may be the worse mortgage rate to be on if the current market interest rate is lower than the interest rate being charged on your mortgage.
A variable or tracker mortgage rate may be the best mortgage to be on as your mortgage rate will go down and hence your monthly mortgage repayment will go down.
Choosing a mortgage type also hugely depends on your financial plans, if you plan on moving homes sooner, a fixed rate mortgage might not be an ideal option due to the fact that the early repayment charges might be hefty and the setup costs are usually expensive too.
Some fixed rate mortgages are portable so this might not be so much of a problem.
So what type of mortgage should you get?
This really depends on your future plans and attitude to risk. interest rates can rise or fall at any time and this might be somewhat hard to predict.
If you are risk averse then a fixed rate mortgage might be your best option as this will give you the most security in case interest rates rise.
If you are less risk-averse and can afford higher mortgage payments then the savings gained from choosing a variable discount or capped mortgage rate might be better and certainly gain you much savings if interest rates stay low for the duration of your mortgage in comparison to a fixed rate mortgage with a higher interest rate.
How do mortgages work as my fixed rate mortgage ends?
what is a fixed rate mortgage?
A fixed rate mortgage is essentially a mortgage where the interest rate is locked in for a set period of time.
This is usually done as an introductory rate discount to attract new first-time buyers and provides certainty on monthly payments if interest rates rise. However, if interest rates fall you will not benefit from this reduction in costs if your mortgage lender reduces their standard variable rate in line with the falling interest rates.
Fixed rates are different from tracker rates which move in line with the bank of England rate.
What you should do when your fixed rate mortgage ends?
Once a fixed rate mortgage ends you may usually move on to a standard variable rate.
These rates are usually 3% higher (but can be much less) than the fixed rate and can be increased or decreased at a lender’s discretion.
Remortgaging at the end of a fixed rate may usually get you to a cheaper rate by shopping yourself out to all current mortgage lenders who will see your good history of mortgage repayments over the past few years and be eager to lend to you.
You can contact your lender first to see if they will offer you a better deal but you will be better served with a mortgage management platform which will analyse your possibilities and the best lender to switch to for the ultimate savings or use a mortgage broker.
Mortgage management platforms will look into your equity in your property if your property price has increased and the LTV ratio you will be using to approach mortgage lenders. A lower LTV may give you cheaper mortgage rates and hence less monthly payments.
It is worth noting that you will have to pass a mortgage lenders affordability test again and this will heavily affect what sort of rates you are offered.
A good mortgage management platform may ensure your complete affordability always stays at is best to ensure you are always eligible for the best mortgage rates.
In some cases, your mortgage lender might wave the mortgage fees associated with a remortgage as a way to get you to get a new mortgage with them. This might not always be best for you and a good mortgage management platform or mortgage broker may be able to analyse your total savings by comparing all possible outcomes.
If you need financial advice and you live in the UK then you could contact the Money Advice service over the phone or via chat for impartial advice.
You can also contact the debt charity “Step Change” if you are in debt and need help.