Before you start looking for a property, you must be confident in how much you can afford to borrow. After all, your new home will be at risk of repossession if you default on mortgage payments.  Lenders will carry out checks on your income, outgoings, credit history and size of deposit.  If you’re self-employed, the lender is likely to want to see your last three years of tax returns, although some lenders will accept less. 

From this information, a lender will give you an indication of how much they would be willing to lend you in the form of an Agreement In Principle (AIP). These are normally an absolute must during a booming housing market. 

With a mortgage comes a monthly repayment amount. How much depends on the interest rate you choose and whether you take out a Repayment or Interest Only mortgage.

Repayment Mortgage – your monthly payment includes an interest amount, plus an additional amount that goes towards reducing the amount you owe. Every month, the loan amount reduces, and you will have repaid the entire amount at the end of the mortgage term.

Interest Only Mortgage – your monthly payment only includes the interest you owe on the entire amount borrowed.  This means that the amount you owe will remain the same and will need to be repaid in full at the end of the mortgage term. The requirements for Interest Only mortgages are normally strict, and you’ll need to prove to your lender that you have a repayment strategy in place.

There are several ways that interest can be calculated and applied to a mortgage, with variable time periods and different rates.  Mortgage rates are changing all the time. This means that when you start looking for a house, the mortgage rate on a particular product may well have changed by the time you’re ready to make a purchase.

Standard Variable Rate (SVR)

This is a standard interest rate that can go up as well as down in line with market rates, such as the Bank of England’s base rate. There is no tie to the lender or product, so you can switch or repay without incurring any early repayment charges. But it is unlikely you’ll be offered the lowest rate available, so you may find yourself paying more than is necessary.

Discounted Rate

A discounted rate mortgage starts at a lower interest rate than the Standard Variable rate for a set time, after which it transfers to the SVR rate. This means that in the early days, you will be paying less. But as with the SVR, payments can still go up and down, making it important to be comfortable that you could cope with the impact of higher monthly payments, if necessary.  There is also likely to be an early repayment fee if you want to repay the loan or switch to a different mortgage deal within the first few years.

Fixed-Rate

If you choose a fixed-rate mortgage, your monthly payments will stay the same for a set period of time (usually two, three or five years). At the end of the fixed-rate period, your interest rate will usually revert to the lender’s SVR, which could be higher than your fixed rate, especially if market interest rates have risen.  

The great thing about a fixed rate is that you know exactly what you need to pay each month, and if the market rates move up, you’re going to benefit.  But if the market rates drop, you may end up paying more than you need to.  Plus, there’s the early-repayment charge to bear in mind should you wish to switch to a different mortgage deal during the first few years.

Tracker

As the name suggests, a tracker mortgage tracks the fortunes of an interest rate, such as the Bank of England base rate. This means your monthly payment may go up or down. Some lenders impose a ‘collar’, which means the interest rate you pay won’t fall below a certain level, even if the tracked rate goes lower. Once again, there is likely to be an early repayment fee if you want to pay the loan off before the end of the tracked term.

Offset Mortgage

An offset mortgage is generally linked to a main current or savings account held with the same lender. Each month, the interest on the total amount owed is reduced by the amount in these accounts. This means as your current account and saving balances go up, you pay less mortgage interest. But as they go down, you will pay more.  

The advantage of an Offset mortgage is that you can reduce your monthly payments as your savings increase, or you may choose to continue paying a higher level and pay your mortgage off early. In addition, you won’t pay income tax on any savings used to offset your mortgage, which is particularly beneficial for higher rate taxpayers.

The disadvantages are that you need to have all your accounts with one lender/bank and have a substantial level of savings. Plus, there is likely to be an early repayment charge if you repay early.

Capped Rate or Capped and Collared Rate

With this type of mortgage, the interest rate is linked to a lender’s SVR but with a guarantee that it won’t go above a set level (called a ‘cap’) or below a certain level (called a ‘collar’) for a set period of time. It’s possible to have a capped rate without a collar. 

These products offer the security of knowing your payments won’t rise above the set level (the cap) but could still benefit if rates fall during the specified period. The disadvantage is that if standard interest rates fall below the collar, you may end up paying more. And once again, depending on the time period set, you may need to pay an early repayment charge if you pay it off early.

The world of mortgages is a tricky one, so if you’re still not sure which option is right for you, one of our mortgage experts can help you decide. They will offer professional advice on the most suitable type of mortgage based on your circumstances, as well as having access to some of the best lenders’ interest rates that you won’t find on the high street.