This guide aims to give you a simple overview of the various types
of mortgage available to you and how they work.
1. Who Provides Mortgages?
For years Building Societies were the main suppliers of mortgages,
but with the flotation of many of the largest into Banks their
share has effectively reduced. These ex-Building Societies, often
referred to as Bank Assurance companies, have combined with established
Banks. Remaining Building Societies have considerable influence
both directly and through their specialist subsidiaries. Means
of access to providers has also changed and much mortgage processing
is now from centralised points. Whilst all this means potentially
more choice in lenders, rates and products, inevitably there is
a greater need to assess and understand the individuals needs
This is where Grosvenor
Trust & Savings, as an independent mortgage broker, can independently
assess your needs and requirements and seek to match you to a
lender and product to suit. We are not limited or tied to any
one mortgage provider and remain independent, concentrating on
our clients needs.
2. Types of Mortgage
There are two types of mortgage - Capital and Interest Repayment
and Interest Only.
a) Capital and Interest Repayment
With a repayment mortgage, each of your monthly payments throughout
the mortgage term comprises both capital and interest. The advantage
of this type of mortgage is that, provided you keep up the repayments,
you can be certain that your mortgage will be fully paid off at
the end of the term.
Repayment mortgages are more flexible than interest only - it
may be possible to extend the term or agree with the lender to
defer repayments over a certain period, for example.
Generally the cost of a repayment mortgage is less than the cost
of an interest only mortgage if the associated investment and
additional interest is taken into account.
For most people a repayment mortgage would be the most suitable
b) Interest Only Mortgages
With an interest only mortgage, you will pay interest on the amount
borrowed for the term of the mortgage. The whole of the amount
borrowed must be repaid at the end of the term.
Therefore, you must ensure that you have a way of building up
sufficient capital during the term of the mortgage to be able
to repay it in full at the end. Usually this will be by using
some kind of investment into which you make regular payments,
such as an endowment policy, Individual Savings Account (ISA)
and Personal Pension Plan.
To be worthwhile, the chosen investment will have to produce
a return which is greater than the sum borrowed and the interest
paid on the mortgage and any tax liability arising on the investment.
The major downfall with relying on an investment to repay your
mortgage capital is that there is no guarantee you will have enough
to repay the full amount when it is due. Relatively poor performance
could mean that the amount available from the investment will
be insufficient to pay off your mortgage, and will subsequently
cost a lot more in interest.
3. Interest Only Mortgages - Associated
Essentially, any investment that could be used to accumulate
a capital sum could be used in association with an interest only
mortgage. However, some lenders do restrict the options available
to their borrowers. The most common types of investment used are
Please note however that with any of these
types of investment there is no guarantee that full repayment
of the mortgage will be possible from the proceeds of the investment
at the end of the mortgage term.
a) Endowment Policies
An endowment policy basically means that you pay premiums to an
insurance company, which then invests your money and, after a
set period of time, pays you back a lump sum. The size of the
lump sum will depend on how much you paid and what type of endowment
you have. There is also an element of life cover included. The
insurance company will take certain charges from your money during
the period of the policy.
i) Without Profits
These provide a guaranteed amount on death or on maturity of the
policy ('sum assured'). This amount will not increase or decrease
so you will know that, if you keep up payment of the premiums,
you will have enough to repay your mortgage at the end of the
term. However, they are unpopular because they are regarded as
poor value for money. They are relatively expensive for the return
that you eventually receive.
ii) With Profits Endowment
Again, a certain amount on death or maturity is guaranteed. As
well as that, you also have a right to a share in the profits
made by the insurance company on all their endowment policies.
This means that you are likely to receive a surplus amount of
money on maturity, after your mortgage has been paid off. However,
this is not guaranteed and depends on investment performance.
The premiums for with profits endowments are expensive.
iii) Low Cost Endowment
With low cost endowments, the sum assured is lower than the amount
of the mortgage that must be repaid. The insurance company assume
a growth rate for your money which, if achieved, will result in
a bonus sufficient to repay your mortgage on maturity, when added
to the sum assured. There is therefore a high risk that there
will not be sufficient to repay the mortgage when required and
you would have to somehow meet the shortfall with your own funds.
'Low start' versions of these are also available, where
the premium starts off lower than it should be and increases over
4-5 years to a level premium which will be charged for the rest
of the term.
iv) Unit Linked Endowments
The premiums are used to buy units in investment funds run by
the insurance company. Initial projections in the policy quotation
are based on assumed growth rates but the actual maturity value
will be the total value of the units at the maturity date. The
unit price is determined by the value of the underlying assets
and can therefore decrease as well as increase. Again, there is
no guarantee that there will be sufficient to repay the mortgage
b) Personal Pension Plans
If a personal pension is used in conjunction with an interest
only mortgage, then the mortgage will be repaid at the end of
the term, using the tax free cash sum available at the time benefits
are taken under the pension.
The main advantage of using a pension in this way, particularly
if you are a higher rate taxpayer, is that it is a tax efficient
way to repay a mortgage. However, a major disadvantage is that
there is no guarantee that the cash sum available will be sufficient
to repay the mortgage and there could be a shortfall. It also
dilutes pension planning because there are then less funds available
from which to pay your pension.
ISAs do not have fixed terms and contributions to them can be
varied as much as you want (subject to the maximum contribution
limits). They are therefore very flexible to use in conjunction
with an interest only mortgage. They are also a very tax efficient
method of saving. However, because of their flexibility, you must
have the self-discipline to maintain sufficient contributions
over the mortgage term. The sum available at the end of the mortgage
term depends on investment performance and may not be sufficient
to repay the whole mortgage.
4. Summary - Capital and Interest Repayment
v Interest Only
- Cheapest way of repaying
- Guaranteed to repay your whole mortgage
- You will build up equity in your home as you pay
- More expensive
- Risk with most associated investments that there won't be
sufficient to repay your mortgage at the end of the term
- Possibility of some surplus funds at maturity
5. Mortgage Interest Rate Options
There are many different types of interest rate option and which
one suits you will depend on your personal circumstances. The
main types are listed below.
a) Variable Rate
The lender will vary the rate charged from time to time in line
with market conditions. This will cause the amount of your monthly
repayments to change.
b) Fixed Rate
The interest rate will be fixed at the start of the mortgage for
a set period, usually 2 - 5 years. The fixed rate mortgages available
at any time will depend not only on current but also future expectations
of interest rate movements. A fixed rate provides you with a definite
monthly repayment amount for the duration of the fixed period.
c) Discounted Rate
This is a variable rate (see above), but where the interest for
an initial set period of the mortgage is charged at a lower variable
rate than normal (e.g. 2% below normal variable rate). Typical
set periods will be between 2 - 5 years.
d) Tracker Mortgages
This type of mortgage is a variable rate mortgage where the interest
'tracks' an index (usually bank base rate). Bank rate changes
influence all variable rate mortgages, but tracker mortgages have
an automatic link built in. Control of the rate is effectively
removed from the lender until the agreed period comes to an end.
These can be for the life of the mortgage or as part of an initial
incentive period (e.g. 2 - 5yrs typically).
e) Capped and Collared Rates
This is a variable rate mortgage. However, a capped rate mortgage
specifies the maximum interest rate that could apply for a set
period and a collared rate mortgage specifies the minimum rate
that could apply. They are often used together. This is a method
of limiting interest rate fluctuations without fixing them entirely.
The level of repayment due from you is therefore reasonably certain.
f) Cashback Mortgages
This is not actually an interest rate option. With a cashback
mortgage, you receive a cash bonus when your mortgage completes,
as an incentive to choose that lender. With significant numbers
of cashback mortgages expect to be tied in with penalties for
a number of years at the lender's normal rate.
g) Flexible Mortgages
Some lenders are now offering mortgages that give you far wider
options with regard to your repayments than ever before. This
is a response to the fact that, generally, people's circumstances
change more frequently nowadays.
More recently there has been a growth in Offset Mortgages where
your savings / current accounts are linked to your mortgage. This
means that whilst your savings attract no interest, amounts held
will 'offset' the mortgage interest charged with resultant savings.
Offset mortgages can be simple savings related schemes or more
comprehensive current account solutions.
Variations and Combinations
Many of the above products can be combined. Recently lenders
have introduced discounts and trackers where the initial start
rate is very low but in later years they reduce the discount given
and increase the costs. This is common with 3 year deals and there
are many variations. This can also extend to fixed rates, with
the initial fixed period being followed by a higher fix or a switch
for a time to some form of variable tracker / discount. These
are commonly known as stepped schemes.
Very low rates usually come with extended penalty overhangs.
This means once the product has ended you will typically pay a
much higher rate but cannot exit without paying a significant
Here at Grosvenor Trust
& Savings we can help guide you through the above products,
looking at your needs now and for the foreseeable future.
6. Points to Note
Depending on the type of mortgage you choose, there are often
special conditions imposed of which you should be aware.
These are generally in the form of early repayment charges
and are usually expressed as a percentage of the loan. If
you move lenders or repay part, or all, of your mortgage within
the time period specified then you will have to pay a penalty
to the lender.
If your mortgage exceeds a certain percentage of the property
value then you may be asked to pay a Higher Lending Charge. When
a lender lends money, their major concern is to avoid losing the
money. To reduce this risk, the lender may take out insurance
(mortgage indemnity policy) to cover loans where a high percentage
of the property value is being loaned, the cost of this is the
Higher Lending Fee.
Other charges may also be made by the lender, such as an arrangement
fee and survey fee.
7. The Mortgage Process
The typical stages involved in arranging a mortgage are as follows.
The steps will be similar apart from finding a suitable property
if you are remortgaging:
a) You decide on the price range of the property you want to
b) We find you a lender suitable for your needs who will give
you an 'decision in principle' to lend to you. This does not bind
the lender to lending you the money. The final decision will depend
on the results of a valuation on the actual property you wish
to buy and also on you being able to substantiate the information
you have provided to the lender (e.g. you may be asked to provide
pay slips or accounts)
c) You find a property to buy
d) You instruct a solicitor to deal with the purchase. The solicitor
will usually also act for your lender to complete your mortgage.
We can recommend a solicitor from our nationwide panel of on line
legal/conveyance firms if required.
Or click on this
link where you can get an immediate quote and instruct a solicitor
e) We usually meet with you, take further details and send a
full mortgage application to the lender
f) The lender processes your application, raises any queries
and arranges a valuation of the property. You may wish to instruct
your own survey as you will not be able to rely on the valuation
arranged by your lender as this is purely to establish that the
property is a suitable security for their lending and not a buildings
g) If all is well, your lender confirms the loan by issuing a
formal offer of mortgage.
h) We arrange any insurance that you may need
i) Your solicitor will in the meantime investigate title to the
property and carry out the necessary searches
j) Once search results are available and you have a mortgage
offer, your solicitor will report to you and exchange contracts.
At this point the date for completion is set
k) We put in force any Insurances we have arranged for you.
l) Your solicitor will prepare the final documentation and draw
down your mortgage advance
m) Completion day - all monies paid and you can move in