There are a huge variety of mortgage products in the marketplace today, and some with very confusing ways of charging interest. Most people, however, have heard about fixed rate and discounted rate mortgages together with that other mortgage foot soldier, the Standard Variable Rate (SVR).
Most people could save money by moving their mortgage from their lenders SVR, which are often as high as 2.5% + the Bank of England base rate. It is usually a question of lethargy or a lack of knowledge which stops people from changing, which is a shame because some lenders exploit this with high interest rates.
Definition of a fixed rate mortgage
Fixed rates are the most highly publicised of all mortgage products. They often advertised with very attractive- even unlikely- interest rates, designed to tempt people away from their existing lenders.
A fixed rate means exactly that. The interest on your loan is fixed at a certain rate for the duration of your offer period; you will spend no more on your mortgage payments if interest rates go up. During the deal period you are usually locked in, with penalties applying if you try to redeem your mortgage.
How can lenders offer rates which seem almost too good to be true? The answer is that the rate reflects the rate charged on a tranche of funds raised in one of the wholesale money markets. The lender then passes on the cost benefits of borrowing huge amounts of money to individual mortgage holders, their profit margin being extra interest charged on top of their negotiated rate. The product is withdrawn when the tranche of money raised is re-lent to mortgagors.
Advantages of fixed rates
Fixed rates enable people to budget in that their monthly mortgage payment is fixed for the offer period. They are protected against increases in interest rates and hence a nice idea for people with smaller budgets. This could be a great option for key workers, people on low incomes and right to buy and shared ownership applicants.
This is really an extension of the first point, but peace of mind is such an important factor for many people regarding their mortgage it could stretch out over several points! If your payments are towards the top end of what you can afford, you should not be gambling with a variable rate. Even a quarter percent base rate rise could result in considerable financial hardship on larger loans.
Disadvantages of fixed rates
It�s fixed! If interest rates start heading south, your fixed rate won�t be as desirable as it was. And if you want to remortgage to another lender during your offer period you can�t because:
An early repayment charge will almost certainly be levied if you redeem or partly redeem your mortgage! These are the clauses which tie people into their fixed rate deals and enable lenders to lend at reduced rates. Hence it is hugely important with fixed rate deals to get advice from a broker on the likely movement of interest rates. In the dog days of the early nineties some borrowers were locked into deals which were two or three times more expensive than others on variable rates.
Beware of �overhanging� early redemption charges. Some deals, admittedly more common a few years back, have early redemption charges which extend beyond the offer period. These are designed to force borrowers on to the lender�s SVR and then hope that apathy rules.
Watch out for high arrangement or booking fees. A current trend is for lenders to publish amazing headline rates, but double or triple their fees. These can be as high as 2% of the loan. Also �back end fees� such as redemption administrative fees have
Fixed rate products tend to be less flexible than variable rate products. Generally speaking, flexible mortgages tend to be on variable rates: these allow payment holidays, overpayments and underpayments.
Make sure there is no compulsory purchase of an associated product such as buildings and contents insurance or mortgage payment protection insurance. These lender- provided policies are usually more expensive than others on the market.
Definition of discounted rate mortgages
Unlike fixed rate mortgages, discounted rates are variable. They usually take the form of a discount off the lender�s SVR. Say, for instance that a building society was offering a discounted rate of -1.5% and their SVR is 6.5%, the rate you would pay for your offer period would be 5%. If the SVR went up 0.5%, so would your discounted variable rate mortgage. Simple as that.
However, some also offer what is known as a �stepped discount� ie the discount increases the further into the offer period. Year one may be -1.0 %, year two 1.25% etc. This is supposed to encourage borrowers to stay with their product.
Advantages of discounted rate mortgages
If you are prepared to take a gamble on interest rates going down, they can pay off handsomely. The borrower who uses a discounted rate is likely to be one with a significant monthly surplus above his mortgage payment ie somebody who can afford to make such a gamble.
You will be paying less than the lender�s SVR, so you will be paying significantly less than most of the lender�s clients. However, you will need to be aware of the differences in lenders SVRs. A discount of 2% sounds good- but what if their SVR was much higher than it�s competitors? Surprisingly, there can be big differences between lenders SVRs.
Disadvantages of discounted rate mortgages
The SVR, although linked to the Bank of England Base Rate, doesn�t necessarily follow it. For instance, a .25% rate rise by the Bank of England may be followed by a rise of .30% by the lender! SVRs are not totally arbitary, but they can be changed at a lender�s whim. Make sure your mortgage provider has a good reputation on that score.
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