There are four main mortgage rate options available:
FIXED CAPPED DISCOUNT VARIABLE
The amount you repay the lender each month can be at a fixed interest rate for a certain period of time, regardless of the interest rate in the market place. It is common for lenders to offer rates fixed for a period of 2 to 5 years, but shorter and longer periods can be found in the market. At the end of the fixed rate period the rate will normally convert to the lenders Standard Variable Rate.
Bear in mind that rates are fixed in line with market expectations of future interest rates, so don't imagine that you can easily beat the market, a fixed rate that looks good now might look expensive after a year, (and vice versa).
The main reason you should choose a fixed rate mortgage is to know for certain what your monthly repayments will be during the fixed rate period, this is most useful if you are borrowing very close to your income limit as a steep rise in the mortgage rate could be disastrous if your rate was not fixed.
It is common for lenders to charge up-front fees in the form of booking and/or arrangement fees. In addition lenders frequently apply an Early Redemption Charge on fixed rate mortgages for borrowers paying off their mortgage early. This charge can sometimes last longer than the fixed rate period.
A capped rate mortgage is very similar to a fixed except that if the variable rate drops below the capped rate, the borrower will make payments based on the lower variable rate. However should rates increase the payments will be capped and will not rise over the capped rate. So as a rough guide a capped rate is better to have than a fixed if all other factors are equal. Again, as with fixed rates, up-front charges and early redemption charges are common.
The Lender offers a discount on the Standard Variable Rate for a specific period of time. For example, the variable rate may be 5% with a discount of 1.5%. The initial pay rate would therefore be 3.5%. If the variable rate rose to say, 6%, then the rate payable would rise to 4.5%. As the discount is linked to the standard variable rate, the borrowers payments will increase, if rates rise – so there is no certainty in budgeting. However should rates decrease the borrower will benefit from lower payments - and the long term trend in rates is down.
It is still possible to have up-front charges for discounted products and an Early Redemption Charge is common.
You need to base your budget on what the monthly repayments will be after the discounted period, this is particularly important if the discount is large as there will be a significant increase in the monthly mortgage payment at the end of the discount benefit period. This is sometimes described as Payment Shock.
Borrowers paying the Standard Variable Rate will have their payments increase or decrease as the lender adjusts the rate in accordance with prevailing market conditions. In theory it would make mortgage products and charges more transparent if lenders would simply offer a competitive Standard Variable Rate and forget about all the incentives and discounts, however lenders that have tried this approach have not found it very popular with the borrowing public.
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