Financial Adviser Hertfordshire

UK Mortgages - An Overview

UK mortgages are funded solely by banks, credit unions, or other financial organizations. There is no market intervention by government entities. This means that the mortgage market in the UK is very competitive. This had led to a variety of types of mortgages available to UK borrowers.

Most UK mortgages operate on a variable interest rate. This rate is usually determined by the Bank of England. However, because the market is so competitive, lenders often offer the borrower terms when they can pay a rate that differs from the variable rate. Lenders sometimes offer borrowers a fixed interest rate for a certain period of time before they will have to start paying the variable rate. Another common incentive is a discount rate. A discount rate is a rate that is lower than the variable rate. Discount rates apply for a certain number of years established by the lender. Some lenders offer capped rates. This is the maximum interest rate that the borrower would be required to pay at any time during the term of the loan.

Some lenders even offer a cash-back incentive. Cash-back incentives are based on a percentage of the principal borrowed amount. Borrowers who borrowed $100,000 with a 5% cash back incentive would receive $5000 in cash at the closing of the mortgage.

Because of the need for lenders in the UK to offer competitive rates, they usually have early repayment charges. This means that the borrower would be charged an additional fee amount if they were to repay the mortgage prior to the end of the early repayment charge period.  It is generally accepted that an early repayment charge that does not extend beyond the term of any discount or fixed-rate deal is acceptable so long as the charge is no more than 5% of the loan balance.   This is referred to as no early repayment overhang.

Here is an example.  A mortgage might be offerred with a standard variable interest rate of say 7% p.a.  To attract new borrowers the lender offers an attractive 3% discount for the first two years.  This brings the rate down to 5% per annum.  The early repayment charge might be 5% of the mortgage balance for the first two years.

Some lenders offer mortgages where the early repayment charge continues beyond the expiry of the product period. These are mortgage with an early repayment overhang. These can appear very attractive because the interest rate can be cheaper but beware.  They can cost you dear in the long run.

For example.  The lender offers a discount of 6% per annum for two years.  That makes the mortgage only cost 1% per annum.  Wow.  So cheap.  How can you lose?  Here is how you lose.  The early repayment charge is 5% per annum for five years.  After two years your mortgage costs jump up.  Now you are paying 7% per annum.  You want to remortgage to bring your costs down but if you do it will cost you 5% of your mortgage balance.  You are trapped paying at the full standard variable rate.  Worse still if interest rates rise you could be paying even more and the only way out is to pay that penatly. 

In certain circumstances mortgages with an early repayment overhang can be suitable.  It all depends on the circumstance but if asked to generalise I would say that most people will be worse-off taking an early repayment overhang mortgage.  An independent mortgage adviser is your best guide on such matters.

Another variation is a stepped mortgage.  These have a a fixed rate or discount that reduces over the early part of the mortgage.

For exampe a 3% discount in year, 2% in year 2 and 1% in year 3.  Some advisers regard these as a softened form of early repayment overhang mortgage that attract you with a cheap rate in year 1 but give you little in year three whilst still tying you in with heavy penalties.  These mortgages are popular through direct sales channels and can catch out the unwary.  Most independent mortgage advisers will steer clients away from stepped mortgages but they do have a place in certain situations.

A more attractive early repayment charge might reduce on a sliding scale.  For example 5% in year 1, 5% in year 2, 3% in year 3, 2% in year 2 and 1% in year 1 for a five year fixed rate.

Another common UK mortgage is a self-certification mortgage. A self-cert mortgage is for people who are self-employed with no means of proving their income. As long as the borrower has a down payment and borrows an amount substantially lower than the value of the home, a lender will offer them a self-cert mortgage. Self-cert mortgages usually have higher interest rates than normal mortgages because of the amount of risk involved for the lender.

Other lenders allow certain borrowers to borrow the full amount of the value of their home. This usually presents a significant risk to the lender should the borrower default on the loan, so 100% mortgages are usually reserved for borrowers with great credit histories.