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The cost of living crisis and soaring inflation means another hike in interest rates is likely, putting further pressure on household budgets
In May, The Bank of England raised its benchmark interest rate to 1 per cent, the fourth increase in a row and the highest level for 13 years. A further rise is expected later this week.
The rise in interest rates has a direct knock-on impact on mortgage holders on a variable rate, adding around £300 a year onto the cost of a £200,000 mortgage (2.25% variable rate).
Many new fixed rate mortgage deals have factored in interest rises, and mortgage rates have been rising steadily in recent months.
Amid the economic turbulence, it can be hard to know what type of mortgage will suit your needs. Here are five types of ways you can borrow to buy a home.
Repayment mortgages
Most types of mortgage fall into the category of a repayment mortgage, which is where you repay some of the capital amount you’ve borrowed, as well as some of the interest on the loan. Eventually you own your home outright. There are two types of repayment mortgage; fixed-term and variable.
With a fixed-rate mortgage, the interest rate is fixed for a set amount of time and won’t be affected by Bank of England base rate rises or fluctuations in the market. Typically, the fixed rate period (also known as the initial rate period) is the first two, three, or five years of the term.
As the name suggests, variable rate mortgages have interest rates that can go up and down meaning your monthly payments can change. There are three main types: standard variable rate (SVR), tracker and discount-rate.
First-time buyer mortgages
For many first-time buyers, meeting deposit requirements is the biggest hurdle to realising the dream of home ownership.
This is where a 95% mortgage can help, as with a home loan at 95% loan-to-value (LTV), you only need to raise a deposit of 5%.
The LTV is a ratio of a home loan relative to a property’s value. For example, a mortgage worth £190,000 on a £200,000 home has a 95% LTV. You then make up the 5% difference with a deposit – in this case, £10,000.
During the uncertainty of the pandemic, banks became much more risk averse and many pulled their 95% mortgage deals. But the product came back on the market after a new government initiative was launched in 2021, providing a guarantee to mortgage lenders to encourage them to offer high loan-to-value (LTV) mortgages.
Major lenders including Lloyds, Santander, Barclays, HSBC, NatWest and Virgin Money all offer 95 per cent mortgages under the Mortgage Guarantee Scheme. The closing date for the scheme has been earmarked as 31 December 2022.
Interest only mortgages
Unlike the above repayment mortgages, interest only mortgages allow you to pay just the interest charged each month for the term of the loan. They may offer cheaper payments at first, but you have to make sure you have a way of paying the full loan bill at the end of your mortgage term.
They are not as common as they were before the credit crunch, and have been the subject of mis-selling scandals in the past.
Since 2014, it has been more difficult to borrow on an interest-only basis. Not all lenders offer interest-only and those that do will have strict criteria such as a decent deposit and an approved repayment vehicle in place.
According to UK Finance, new interest-only lending, while still permitted, accounts for only a small minority of activity. Just 32,000 interest-only loans were advanced in 2021 – less than three per cent of total lending.
‘Part and part’ mortgages
There is also a half way option between interest only and a traditional repayment mortgage. Called ‘part and part’ mortgages, these allow you to pay off some of your mortgage over time, but not all of it. When the mortgage term ends, there will still be some money left to pay off.
Experts stress that specific financial advice should be sought to ensure that there is a full understanding of the part and part set up, and any later financial considerations have been taken.
Lifetime or ‘reverse’ mortgages
Available to homeowners aged 55 and over, a lifetime mortgage, sometimes called a ‘reverse mortgage’, is a loan secured against your home that allows you to release tax-free cash without needing to move out. It’s a type of equity release, freeing up wealth tied up in an asset but allowing you to carry on living in the property.
Unlike conventional mortgages, where interest is charged on an amount that decreases with time, interest on lifetime mortgages is charged on an increasing sum, so your debt can grow quickly.
This is because you don’t usually make any repayments, so the interest on the loan is therefore added to your debt on a continual basis.
You can take the money as a lump sum or as series of lump sums. No repayments are required until you die or move out of your home into long-term care.
What the experts say
Rachel Springall, finance expert at Money Facts had the following advice for buyers: “Considering the different terms of deals in the market and the rise in the cost of living, borrowers looking for peace of mind may want to consider fixing for longer, such as with a five-year fixed mortgage.
“Seeking independent financial advice is always a good idea not just to check the current deals but to also offer guidance when it comes to eligibility criteria and take away any anxiety of monitoring a direct application.”
“House prices have increased in many areas of the country which can mean more equity in the home and more of a possibility for remortgage customers to get a cheaper mortgage.”
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