You might think choosing which house or flat to buy is tough, but wait until you have to pick a mortgage.
There are thousands of home-loan deals available, each slightly different from the last. So how do you decide which one suits you best? Here’s a guide to help you work it out.
How the mortgage market works
To start with, it’s a good idea to understand how banks and building societies market their mortgages. In the vast majority of cases, new buyers sign up for a 25-year loan. But the type of mortgage they choose at the outset – whether it’s a fixed-rate or a tracker, say – will generally only apply for the first few (three or five, for example) of those 25 years.
After this initial period ends, your loan will change to the lender’s standard variable rate (SVR) of interest: this is normally a bit more expensive than the deal you’ve been on, but at this point you’ll be free to move to another, cheaper, mortgage without having to pay a penalty.
Savvy borrowers will continue moving from one deal to the next throughout the whole 25-year term.
The flipside to this is that if you sign up to a mortgage that turns out to be unsuitable or more expensive than you thought, you might face a fee of thousands of pounds if you want to switch before the initial three- or five-year period is up.
That’s why it’s important to get the choice right at the outset.
Getting the best deal
Unlike with savings accounts, where it’s quite easy to see what the best rate is, the best mortgage for one borrower may not be right for another.
Choosing your loan on interest rate alone does not guarantee success.
There are two major factors that will dictate what kind of mortgage is right for you.
First of all, do you want your monthly repayments to be fixed for the initial period, or are you happy for them to rise or fall in line with interest rates in the wider economy?
And secondly, how long do you want the initial period to last – how long are you happy to be locked in for?
Fixed versus tracker
If you opt for a fixed-rate mortgage, you have the peace of mind that your repayments will not go up for however long the deal lasts. (Fixes are normally two, three or five years long, but you can tie in for longer if you wish.)
That might sound great, but if you sign up for a long-term fixed loan today and rates on rival deals fell next year and the year after, you might end up rueing your decision – although with interest rates already pretty low, this might seem unlikely right now.
With a tracker, however, you would benefit from future falls in interest rates (say if the Bank of England cut rates even further), but your repayments would go up whenever rates rose.
A premium for peace of mind
Another issue to bear in mind is the cost of each type of deal when you sign up: for example, you might be eligible for a five-year fixed rate loan today at 4.5 per cent a year, or a five-year tracker at 3.5 per cent.
If you go with the tracker, your repayments will be lower at the start: but you’d be taking a gamble that rates wouldn’t rise very fast over the next five years.
You could view the 1 per cent difference (or whatever it happens to be) in these deals as the cost of an insurance policy that you’ve effectively taken out to protect yourself against future mortgage repayment rises.
If your repayments are already near the limit of what you can afford, it might make more sense to take out a fix.
If you are less worried about possible repayment rises, however, and expect rates to stay low – as many people do at the moment, given the dire economic situation – then a tracker may be more appropriate.
David Hollingworth from mortgage broker London & Country says: “The initial dilemma for borrowers is in deciding whether to fix or go for a variable rate that is initially cheaper but carries the risk of climbing costs when base rate does start to rise.”
How long to lock in for?
The next question is how long you want your mortgage’s initial period to last – remember, during this time it will probably be expensive to change your deal.
You may be able to move house during the initial period and take the loan with you without facing exit penalties, but this is not always guaranteed.
Hollingworth says: “Many will like the look of the cheap fixed rates on offer at the moment, but this then begs the question of how long to fix for.”
He adds that there are currently 10-year deals at less than 4 per cent a year, but it is important to consider the potential consequences of being locked in for that period.
“If there is a need to review the mortgage then it could result in having to incur an early-repayment charge: for example, if a move of home is on the horizon the deal should be portable. But if the lender cannot meet the new borrowing requirement then it could pose a problem.
“Many people will therefore prefer a shorter tie-in period to leave more flexibility.”
If you are moving somewhere you expect to stay for a long period of time, you may be happier to go for a longer-term deal.
Even if you opt for a tracker, you will have to decide how long the initial deal lasts. With rates currently low, the longer your tracker continues, the greater risk there is that repayments will rise.
However, if rates remained at their current low level for the next five years, say, taking a five-year tracker today could turn out to be a shrewd move.
Again, though, you are taking a gamble on future interest-rate movements: if this worries you, go for a shorter period, or for a mortgage that doesn’t charge a penalty for switching early.
The best deals today
London & Country has compiled two tables highlighting some of the top fixed-rate and tracker deals available at the moment, with a variety of initial-period lengths.
You should bear in mind that not every loan is open to all potential borrowers: most have a limit in terms of how much the lender will offer in relation to the value of the property you’re buying (or remortgaging).
The best deals are normally a maximum of 60-75 per cent loan to value (LTV).
This means the lender will only advance between 60 and 75 per cent of the property’s current market value – so on a £200,000 home, this would be between £120,000 and £150,000. The remainder would have to be made up out of your own pocket as a deposit.
There are deals available at 80 and 90 per cent LTV, but these are likely to charge higher interest rates.
