Types of Mortgage
So many types of mortgage
As a potential mortgage-buyer, one of your biggest challenges is finding a route through the minefield of different types of mortgage. In the paragraphs that follow, I'm going to try to explain some of the variants of mortgage on offer, and the pros and cons of choosing them. As you read through, always remember that none of these are inherently 'better' or 'worse' types of mortage than the others. In mortgages, as with everything else, you get what you pay for, and good conditions in one aspect will be balanced out - either by worse conditions elsewhere, or by higher interest rates and fees. That's not to say that you can't improve your deal by shopping around - you can, of course. But you should be looking at these types of mortgage not to find the secret best deal, but to see which best suits your personal needs.
With that preamble done, let's get on to looking at the types of mortgage....
Variable-rate mortgages
The variable-rate deal is the standard mortgage deal, historically the most prevalent, and the one against which people tend to measure the other forms. They tend to have low charges and low interest rates. But they have the downside of exposing the borrower to risks outside of his or her control - risks dictated by the economy as a whole, hard to predict and hard to plan for.
The key feature here is that the amount of interest you pay will vary depending on the national rates of interest. The nationwide interest rate is an outcome of the overall macroeconomic situation of the nation and the world, and its fluctuations are opaque to all but the most knowledgeable experts.
What does that mean? It means that if you buy a variable-rate mortgage, you don't know how much you'll be paying next year, or the year after that, or the year after that. Now, if you're in a good financial situation, and you have easily enough money to cover the cost of the mortgage, that might not be a proble. And, as I said, variable-rate mortgages tend to work out cheaper than fixed- or capped-rate mortgages, averaging out over the good and the bad years. But that "expected outcome" won't be much consolation if you're left owing more than you can pay because of an unexpected rise in interest rates.
Fixed rate mortgage
In a fixed rate mortgage, your interest payments are set in stone for a set term. Regardless of fluctuations in the money markets, regardless of whether nationwide interest rates rise or fall, your payments will stay the same. The rate isn't fixed forever, but for a term, typically between two and five years. What happens after that will vary from lender to lender, and it's something you should ask about before you enter into a fixed rate mortgage agreement.
Fixed-rate mortgages make most sense for thsoe of us who are 'risk averse' - that is, people who don't like facing nasty unexpected shocks in the form of rising interest rates. The catch is that you can find yourself paying more than everybody else if interest rates fall. It's not usually a bad trade-off, since knowing your outgoings in advance makes it much, much easier to plan for the future.
Once you have signed up to a fixed-rate mortgage, you may find it quite hard to get out of it. There's an obvious economic reason for this. If a lender were to offer fixed-rate mortgages with easy get-out options, they would find that people kept their mortgages when national interest rates increased, making the existing fixed-rate mortgages a good deal. But when national rates fell, people would dump their fixed-rate mortgages and go for cheaper variable-rate mortgages from other lenders. Without some kind of lock-in, fixed-rate mortages are a catch-22 for the lenders: customers will keep the mortgages when they become a bad deal for the bank, and drop them when the bank would have a chance of making money.
The upshot of this is that it is typically very hard to get out of a fixed-rate mortgage (at least without paying large penalties) and there is often little flexibility in other ways (such as the ability to pay more or less than the standard amoutn due, during a certain period).
Capped-rate mortgages
If the thought of paying over the odds when interest rates fall sickens you, then you should look into the option of a capped-rate mortgage. This is a variable rate mortgage, except that you have a promise that the interest rate will never go over a set figure. The amount charged you may fall below that, but it will never rise above it.
Sounds like the best of both worlds, doesn't it? And indeed, capped rate mortgages do have a lot to boast about. But remember what I said above - there's no such thing as a free lunch. Capped-rate mortgages tend to come with higher fees, and the caps may be considerably higher than the current interest rate.
Discounted rate mortgages
Discounted rate mortgages are the ones which seem good, but have a sting in their tail. They can be a good deal, but more than other types of mortgage they require you to take a hard look at the figures and to avoid being lulled into a false sense of security.
The way a discounted-rate mortgage works is this. Your lender will offer you a low rate for a certain part of your term - maybe the first six months, or the first year. After that, the rate will increase up to a higher standard level.
The danger here is obvious: you can start to think that your mortgage is cheap, and then be shocked when the discounted term runs out and the cost increases. But as long as you plan carefully, these mortgages can offer a good deal overall. Just be sure not to let yourself be seduced by the initial discount, and remember that the bulk of what you pay over the lifetime of the mortgage will be charged at the non-discounted rate.
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