Save Before You Buy a Home
Before the worldwide mortgage collapse, the UK real estate market was one of the most active in the world. UK mortgages differ from those in many other areas of the world in that the government rarely intervenes in the market. The main influence of the government is in the setting of interest rates by the Bank of England (BoE) and in particular the BoE’s repo rate, and to a lesser extent the London Interbank Offered Rate (LIBOR).
Most mortgages in the UK revolve around a variable rate that is either the lender’s standard variable rate or a BoE tracker rate. As the market has been minimally regulated since 1982, there are a wide variety of mortgage products to choose from.
When are UK mortgage rates low?
Historically, investors have used money markets to forecast mortgage rates in the United Kingdom. When investors feel the base rate is about to be cut, mortgage rates tend to head downward.
So tracking what is going on at the Bank of England is a good way of predicting the direction of mortgage rates. Generally, the BoE tends to cut rates whenever there is a need to stimulate the economy. The base rate may be raised when there is a danger of inflation.
Due to the recent housing market crash and the desire to avoid further erosion in housing sales and values, interest rates will likely stay low for some time to come.
Types of interest rates on mortgages
There are four basic types of mortgage rates available in the United Kingdom:
- Fixed rates – The fixed rate mortgage has a set interest rate for the term defined in the contract that usually ranges between six months and five years. After the term, the lender’s standard variable rate is used. Since the rate will not change during the fixed period, this type of mortgage is desirable for those who want as much predictability as possible. However, if rates go down during this period, the fixed rate mortgage remains the same. If you try to refinance your mortgage during the fixed period, the lender may impose penalties.
- Variable rates – In this type of mortgage, the interest rates change based on the lender’s standard rate. Such mortgages may appear attractive when interest rates are low, but the disadvantage is that they can fluctuate unpredictably. Variable rate mortgages are generally not recommended for the average buyer.
- Discount rate mortgages – These mortgages are special deals offered by lenders to spur sales. The discount is offered on the lender’s standard variable rate for a fixed period that usually lasts between six months and five years. After that period, interest payments shift to the lender’s standard variable rate. Usually discounts are higher for shorter fixed periods than for the longer ones. Many buyers will choose discount rate mortgages to take advantage of current low rates with plans of refinancing their mortgage before the end of the fixed period. However, you should make sure that the lender does not impose penalties for such refinancing before the term has ended.
- Capped rates – With these mortgages you pay a certain rate that will never exceed a cap or upper limit. However, if rates go down the buyer benefits. For this reason, capped rate mortgages are often desired when buyers believe that interest rates will rise in the future. The period for capped rates can vary from months to the entire duration of the mortgage. Thus, the capped rate mortgage is good protection against higher rates in the future. However, capped rate mortgages are generally more expensive upfront compared to those using fixed rates. Some lenders may also impose penalties if you want to refinance your mortgage at any time during the capped rate term.
Types of mortgage products
The UK has one of the most advanced mortgage markets in the world with a very large number of products to choose from, and this can confuse some consumers.
While it is always a good idea to consult with professionals when making your decision on a mortgage product, educating yourself as much as possible at the onset will help you in making an informed choice. Here are some of the types of mortgages available.
- Pension mortgages – Based on your tax-free pension after retirement. The tax-free lump sum is used to pay off the loan after the mortgage term expires.
- Self certification mortgages – The buyer certifies their own income through self certification. Normally wage slips are used to determine salaries, but some workers who depend more on irregular types of pay can use this type of mortgage.
- Endowment mortgages – Life insurance and other funds are used as endowments to repay the loan at the end of a term that usually lasts from 20 to 25 years.
- Individual Savings Account (ISA) mortgages – These mortgages are similar to pension and endowment mortgages but are based on the Individual Savings Account as the means of loan repayment. As with endowment mortgages, if the funds are not sufficient to cover the loan, you will face a remaining balance that still needs to be repaid.
- Repayment mortgages – Normal mortgages in which the borrower makes payments every month until the debt is fully paid.
- Interest only mortgages – With this type of loan you pay only interest payments until the end of the mortgage term, at which time you must repay the entire balance on the mortgage. The hope here is that the money that would be used for actual payments on the balance can be favorably invested elsewhere. If the investments do not perform as expected, the borrower may end up paying substantially more in the long run.
- Buy to let mortgages – Many people buy properties as investments that they plan on letting out to help increase their return. The rent money can help offset one’s mortgage payments. In order for this type of mortgage to work, the borrower must research the market to ensure they will be able to let the property without too much trouble. Lenders have special mortgage rates for buyers who intend to let their property. Normally higher deposits well are required and the rent amount should be at least 130 percent of the mortgage payment.
- First time buyer mortgages – First time buyers often get special deals from lenders based on the buyer’s salary. In most cases, a deposit of at five percent will be required for such loans.
UK mortgages are not that much different than products found in other countries but it pays to know specific details of mortgage rates and products in order to get the best return on one’s investment.