Interest Types
Whether you have a repayment or interest-only mortgage, you’ll have to pay interest to the lender. There are a number of options:
Variable Rate
Some people take a mortgage with a variable rate – the rate goes up and down, usually in line with movements in bank base rates. Falling rates are good news, since the monthly payments go down, but of course rising interest rates mean increased payments.
Most lenders offer a standard variable rate mortgage.
Pluses:
The chance to benefit from falling interest rates.
Minuses:
Rising interest rates mean higher monthly payments.
Lender’s variable rate may not be competitive.
Discounted rate
Many lenders offer variable rates with an initial discount for a period of months or years.
Pluses:
The chance to benefit from falling interest rates.
Minuses:
Rising interest rates mean higher monthly payments.
Lender’s variable rate may not be competitive.
Possible redemption penalties.
Cashback
Some lenders offer new borrowers a variable rate mortgage with a cashback –
a lump sum, which is normally a percentage of the loan, which is payable when the mortgage completes.
Pluses:
Handy upfront cash payment.
The chance to benefit from falling interest rates.
Minuses:-
Rising interest rates mean higher monthly payments.
Lender’s variable rate may not be competitive.
May have to pay back some or all of the cashback if you redeem the loan within a certain period.
Fixed rate
You can get a fixed interest rate mortgage, with a known interest rate for a set period. Most people choose to fix for between two to five years.
Many fixed rates are lower than the standard variable rate, and usually the longer the fixed term, the higher the rate.
Fixed rates are good for budgeting, since you know exactly how much you will pay each month for a set period. They also provide protection, should variable rates rise during the fixed period. However, if variable rates drop below the fixed rate, you could pay over the odds.
Most fixed rates have early redemption penalties during the fixed term, and possibly after the fixed rate runs out. This is a fine, which is often equivalent to several months’ interest, that you have to pay if you cash in your home loan before the end of the fixed term. And, in some cases, early redemption charges may apply for some years after the fixed period runs out.
Pluses:
Good for budgeting.
Rate may be lower than variable rate.
Choice of periods to fix over.
Protection against rising variable rates.
Minuses:
Don’t benefit from falling variable rates.
Hefty early redemption penalties (during and even after the fixed rate period) may lock you into the lender and loan for a long time.
Capped rate
Offers the benefits of variable and fixed rates. Great for budgeting as there is a maximum interest rate (the cap) you will be charged for a period of years. But if the lender’s variable rate falls below the capped rate, so will your rate, and you benefit from lower monthly payments.
Some capped rates have a collar or floor, which is the minimum rate that will be charged for a period.
In some cases, early redemption penalties may apply.
Pluses:
Good for budgeting.
Protection against rising variable rates.
Chance to benefit from falling variable rates.
Minuses:
Limited choice of loans.
Possible collar or floor below which the interest rate won’t fall.
Early redemption penalties may lock you into the lender and loan, for a long time.
Current account and offset mortgages
Current Account Mortgages (CAMs) and offset mortgages allow you to run all of your finances through the same account.
With a CAM, your current account, savings, mortgage, credit card and personal loans are all combined in one account and interest is applied at the mortgage rate, which is always higher than savings rates. So the money that would normally be in your savings or current account goes into your CAM instead to reduce your mortgage debt. So you pay less interest on this reduced amount, and your money is working harder.
The offset mortgage works in a similar way to the CAM, but your mortgage, savings and current account are kept as separate products. So the saving and borrowing rates are offset against one another, but you can view your different ‘pots’ of money separately.
Pluses:
Very efficient way to manage your finances.
Pays off your mortgage quickly if always in credit.
Interest on savings applied at the mortgage rate.
Minuses:
May have to pay in all of your salary into a CAM thereby losing choice.
Can have restrictive entry levels.
