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In the UK, mortgages used to come in two main types, interest-only and repayment.  Now, it is practically impossible to take out an interest-only mortgage on a residential property (although it is still entirely possible to take out an interest-only mortgage on an investment property), which does relieve residential buyers in the UK from one key decision, but does leave them with another, namely, which specific type of repayment mortgage is the right one for them.

Standard repayment mortgages versus offset mortgages

Offset mortgages have been available in the UK for several years now, but they are still very much the newcomers in the UK mortgage market and as such may benefit from a bit of explanation.  The idea behind offset mortgages is that borrowers keep their cash savings with their mortgage lender, which then calculates the interest payable on the net amount (i.e. the outstanding balance on the mortgage itself minus the positive savings balance).  Borrowers keep access to their savings and can use them any time they need to.  In principle, this approach should provide a net gain as savers typically receive less interest income than borrowers pay in interest expense.  Objectively speaking, however, in and of itself, the calculation may be less straightforward as different savings products pay different levels of interest income and different mortgage products charge different levels of interest (and the same mortgage product may charge different levels of interest to different borrowers).  Having said that, it’s important to remember that tax is charged on interest income and hence forgoing it in exchange for reduce interest expense may generate meaningful savings, particularly for higher-rate tax payers.

Variable-rate mortgages versus fixed-rate mortgages

In and of themselves, variable-rate mortgages and fixed-rate mortgages probably need no further explanation, as the old saying goes, the clue is in the name.  It can, however, be rather more complicated to decide which one is right for you.  In theory, it might seem like a good idea to go for a variable-rate mortgage while interest rates are heading downwards, but fix when they look likely to head upwards again.  That way, you benefit when interest rates go down, but limit your losses when they go up (again).  In practice, however, there is a very real problem with this theory, which is that lenders are only too well aware of the fact that fixed-term mortgages shift the risk of interest-rate changes from the borrower to the lender and hence generally charge a premium to protect themselves from this risk.  In addition to this, lenders will typically only grant fixed rates for a specific period of time, and the longer that period of time, the higher the “fixed-rate premium” will be as the lender is assuming a greater degree of risk.  Once this initial period is over, you will either have to renegotiate another fixed-rate deal or move to a variable rate.  In other words, fixed-rate mortgages can work out more expensive than their variable-rate counterparts, plus they can involve a bit more administration.

On the other hand, however, fixed-rate mortgages do give borrowers stability and the reassurance of knowing that their payments will be the same from one month to the next regardless of what happens with interest rates and for some people this stability may be worth the extra money.  In particular, fixed-rate mortgages may be of benefit when interest rates are showing some level of volatility, perhaps going up or down a little each month, rather than either remaining constant or trending clearly in one direction or another.  In this situation, knowing that you’re going to be making the exact same mortgage payment each month, at least for the length of the fixed-rate period, can make budgeting a whole lot easier.

Your property may be repossessed if you do not keep up repayments on your mortgage.

 

Taryn

Author

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