A mortgage loan is likely to be the biggest personal loan you will ever obtain in your lifetime, and the most important consideration with any mortgage deal is how much the mortgage interest rate is going to be, as this will directly affect the amount you have to pay each month.
Interest repayment arrangements vary between lenders and from deal to deal, but basically fall into five categories:
â?¢ Fixed Rate
â?¢ Variable Rate
â?¢ Capped Rate
â?¢ Discounted Rate
â?¢ Fix and Track
A fixed rate mortgage specifies a fixed interest rate, which is constant for the life of the mortgage. If buyers expect interest rates to rise over time, they tend to prefer fixed-rate mortgages, because their interest payments will be sheltered from rising market rates. But there is a serious drawback in this scheme, as you cannot guess the market rate for the coming ten to twenty years, and if the market rate starts falling, you stand to lose money. And if you want to get out of the deal you will probably have to pay a fairly hefty early redemption penalty. Arrangement fees for fixed rate deals can also be much higher than other types of mortgage.
An alternative to a fixed rate mortgage is the variable rate mortgage, in which the interest owed changes in response to movements in a specific market-determined interest rate. Most mortgage lenders have a standard variable rate (SVR) based on the Bank of England's base lending rate, and this is decided at monthly meetings of the Bank's monetary policy committee, or MPC. Most variable rate mortgage deals specify a relatively low initial mortgage rate over the first year or so to get you started, but you must remember that this is only temporary, and your premiums could jump significantly at the end of the introductory period.
A capped rate mortgage contract typically specifies caps, or a maximum and minimum fluctuation in the interest rate. For example, a variable rate may have a cap of 2 percent per year, which prevents the mortgage rate from being adjusted upward by more than 2 percentage points from its existing level in each year. Assume the market interest rate increases by 3 percentage points from one year to the next. Without the cap, the variable rate would increase by 3 percentage points. With a 2 percent cap, however, only an increase of 2 percentage points will be allowed in that year. This cap is useful as it limits the potential increase in mortgage payments that may result form a large increase in interest rates.
Discounted Variable Rates
In a discounted variable rate mortgage, the lender offers a much lower interest rate, below their standard variable rate, for a year or two. Just like any variable rate mortgage, your payment fluctuates with the market rate, but you still pay less. But your lender is not here for charity, so he is definitely going to get compensated in other ways, like a longer mortgage term, higher early redemption penalty and other fees. So read between the lines before you sign the contract.
Fix and Track
This concept is comparatively novel. It is designed in such a way that the buyer pays on a fixed rate for a year or two, and then the interest rate oscillates with the Bank of England's base rate. So in other words, the rate starts tracking the base rate for the rest of the term.
Author Maria Wallanderdate added 2009-09-02 19:13:26