Mortgage Types Jargon Busting

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Mortgage Types Jargon Busting

Mortgage Types Jargon Busting

Richard Campo breaks down the most common types of mortgage jargon.

What’s a fixed rate mortgage?

A fixed rate does what it says on the tin. You have a fixed payment for typically between two and 10 years. The most common periods are two, three, five, seven and 10 years. The most common are two, five and 10.

Banks offer you a fixed rate which is great if you need to budget or money is tight. Your monthly repayment stays level for that period, then  you go onto the lender’s standard variable rate. Then you renegotiate again. It’s probably the most simplistic product and great from a budgeting perspective.

What is a variable rate?

A lender’s variable rate is not linked to the Bank of England. It’s often called the standard variable rate and is set by that specific lender. Some do link their variable rates to the base rate, but these are few and far between. 

As we are, at the end of 2022, most lenders have a variable rate between 6% to 7%. Variable rates tend to be 2% to 3% above the base rate. Lenders then offer more competitive products, because borrowing at 6% isn’t great unless you’re doing it for a reason. If you’ve got a move coming up or you want to borrow for home improvements, for example, because variable rates don’t tend to have penalties attached to them.

What is a tracker rate mortgage?

These products are set at a margin above the Bank of England base rate. Let’s say a lender offers you 1% above the base rate for two years. A good deal is about 0.5% above base, going up to about a 2% margin above base depending on your credit profile and your deposit. 

If you’ve had a few credit blips or you’ve got a small deposit you might find you’re at the upper end of that curve. Tracker rates tend to be short-term because they are variable, so most people take a two-year rate period – you get a nice low margin and then you simply renegotiate after that period. You do get term trackers and penalty-free trackers, which are a bit more expensive, but good if you’re in a situation where you might pay your mortgage off and want to be penalty free. 

What is a discounted rate mortgage?

Funnily enough in 2022 we’ve sold more of these products than we ever have in our eight year history. In simple terms, this is a discount off the lender’s standard variable rate. 

Let’s say the bank’s variable rate is 6%. They might offer you a 3% discount so you’d pay 3%. Much like a tracker, it would go up and down depending on what happens with the bank – but it is not linked to the Bank of England. 

The reason why we’ve done so many discounts recently is because the margin is very high on discounts and the variable rate, coming out of 13 years of ultra-low interest rates. Sadly those rates are gone now and that margin is decreasing. We think variable rates won’t go up as much as the base rate.

That’s why discounts are really great value at the moment. They are a lot cheaper than fixed rates currently.

What is an offset rate?

An offset can be attached to any one of the products I just mentioned. It’s more of an option than a product. As a simple example, you could have a £200,000 mortgage and you’ve got £100,000 in savings. What you can do is put those savings into a linked offset account and only pay interest on the £100,000 difference on the mortgage. 

It’s important to understand the functionality of this because some banks will decrease your payments to represent the lower amount outstanding. Some banks make the normal payment so you effectively overpay the loan. You can also reduce the term as well. 

You need to go into these deals with your eyes open and know your objective – is it to keep costs down? Do you want to pay the loan off faster? Some banks have a default setting that might not match yours. Lender choice is really important when you look at offsets, to make sure you get exactly what you want.

What’s the difference between capital repayment and interest only?

A repayment mortgage is the simpler one – it’s like a traditional loan. You borrow an amount of money, you pay monthly interest and the capital off so that at the end of the term, it’s all completely paid off. With interest only, let’s say you borrowed £100,000. That debt would still be remaining at the end of the 25 year term, unless you do something about it. 

People tend to choose interest only when they have other savings to pay the loan off with. You might have other assets you might look to sell – your business for example. Or you might have a really good income and want to pay the loan off a bit faster. 

Bankers like this sort of thing because they will have a good salary, plus the same again in an annual bonus. It keeps your payments down through the year and then when your bonus comes in you can then chop down your mortgage. That’s great for those sorts of clients. 

A third option which we do a lot of is ‘part and part’ – you could have half of the loan as repayment, half in interest only. Then you’ve got the ability to then repay the loan by downsizing – a lot of people tend to do that. 

We’re primarily based in London and the south east. A lot of our clients aren’t even from the area – they want to pay as much of their mortgage as they can but when they come to retire, the equity in the property pays off the mortgage and they buy a property to retire in.

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What is a flexible mortgage and how do they work?

I touched on this with the offset – there is no solid definition of a flexible mortgage. It’s not a specific product.  To some banks, a flexible mortgage can simply mean the ability to overpay the loan.  Most banks will let you pay off 10% of the mortgage balance each year without any penalties. But typically if you want to pay off more than that it might be deemed a flexible loan, especially if you can make unlimited overpayments. 

Some lenders give you things like payment holidays. Let’s say, for example, my mortgage payments are £1,000 a month and I’ve overpaid by £3,000 this year. I could then underpay by £3,000 the next year. You effectively have to build up the credit. 

Then you get things like cashback and porting. But porting really is a standard feature on every loan. To call that flexible is a touch misleading.  There’s no one definition, so we will always speak to a client about what they really need. Do you want the ability to offset because you’ve got lots of cash? Again this is great for self-employed people. If you’ve got a tax bill coming up, you can pop that in the offset account and get really good use of that money before you pay your tax. 

If you have a high bonus, do you want something that’s penalty free to pay off the loan really quickly? The faster you pay it off, the less interest you pay.  Then we’ll find the best lender we can. There’s no point going to a very expensive flexible mortgage if you’re not going to use half the functions. We’ll keep your costs down and get that mortgage paid off as quickly as possible.

What is a Joint Borrower Sole Proprietor Mortgage?

This is sort of a rebadged guarantor loan. It used to be typically for parents helping children onto the market. But we’re now seeing children helping parents stay in their home. The principle is fairly simple – it’s a joint mortgage with two or more people named on it. But only one of them is on the property deeds. 

It’s really effective because if you’re helping a child or helping your parents, there are no tax implications for you. You simply have to afford the loan jointly together – so it makes affordability easier and gets around stamp duty issues as well. Quite a few of the main banks offer this now as an option. 

With house prices continually going up, it’s a great way of helping people onto the ladder or helping people stay in their homes for longer.

What is Shared Ownership?

Shared ownership has been around for a long time now. It’s typically in partnership with a housing association. What you do is buy a chunk of a property – typically 25% plus – then you rent the remainder. I might buy 25% of a property valued at £100,000. I’d need a 5% deposit which is a couple of thousand pounds.

Then I pay rent on 75% of the property value. If the market rent was £1,000 a month I’d pay £750 rent on my share. Why I like this scheme because we can do something called staircasing. So as my income increases I could take my 25% stake to 40% or 50% until I buy the property outright. Every time you staircase, your rent decreases, so it’s a positive cycle. 

Another good thing is that you can buy a bigger property than you can afford on day one. You don’t have to move, so it keeps your costs down. I’m a big fan of the scheme when it’s used effectively. But you just need to know how to work it all.

What other schemes are there now that Help to Buy has ended?

That’s left a bit of a hole If you’re a developer – it was a very successful scheme. What we’re already seeing, which I think will continue, is developers stepping in and replicating that scheme. 

Let’s say the big builders out there – Barrett, Wimpey, all those sorts of guys – they’ll acquire 40% or 60% percent of the property with you, you mortgage the remainder and then you can buy the chunk out just like Help to Buy. You just work with the developer instead of the government. 

From an investment point of view there are big pension funds that want exposure to property, and this is a great way of doing that. So this could become more of a private thing rather than having government support.

What else should we be aware of with mortgage products and schemes?

There are a couple of things that clients ask me about and a common one is APRC – annual percentage rate calculation. It can be extremely misleading for mortgages and I wouldn’t get overly hung up about it. It caters for two things that you have no control over. 

Let’s say you get a 25 year mortgage and you go for a five-year fix at the beginning of it. That APRC will calculate the first five years at the fixed rate of interest. But it will then calculate the remaining 20 years of interest at the lender’s highest standard variable rate. 

As we already touched on, that variable is likely to change. You’re likely to remortgage, you might repay the loan. So don’t get hung up on an APRC. What we do as a broker is work out the total cost over the initial product period – so how much you will spend over the first five years. Then we review you after that point.

Another bit of jargon that comes up a lot is the start date of a mortgage. When you first get your quote from your broker or a mortgage offer it assumes a start date. It’s not when your first payment will be – they just have to assume a start date. So don’t get hung up on that. 

Everyone always worries about when their first payment is going to come out. It’s typically the first of the month, but there is flexibility around that. If you want a different day just talk to your broker about it. You can rest at ease because the bank will write it to you letting you know when your first payment is and how much. The rule of thumb is if you’re completing in the second half of the month, your first payment will probably be the first of the following month. If you’re completing the first half of the month it’ll probably be the first of the next month.

Finally, just to circle back on products – we can talk about products all day long but it’s boring – If my job was just talking about that I wouldn’t do it for a living. The interesting bit is the relationship between them. If fixed rates are more expensive than variable rates, it means we’re expecting interest rates to rise. If they’re about the same, we expect interest rates to be flat and if fixed rates are cheaper, we’re expecting interest rates to fall.

At the end of 2022 this is really relevant because over the next six, 12 or 18 months all of those scenarios are likely to happen. It’s really interesting. If a fixed rate is 0.5% cheaper than a variable rate, we might expect the base rate to come down by 1%  – so look at the product you’re being offered now. What’s your risk appetite? What horizon are you doing this over? That’s ultimately how you decide what product is best. 

We don’t just pick one, we look at the relationship, the differences, the margins and money market rates. We’re here to make sure that you’re getting the right product for you based on your risk appetite and saving you as much money as possible. 

Your home may be repossessed if you do not keep up with your mortgage repayments.