Andy Coates Blog

Before i started the process of moving house I knew very little about mortgages, there were so many to choose from and I was quite skeptical about the "hidden costs" with some offers! So here is a very quick post to anyone who is considering taking out a mortgage soon, a kind of beginners guide to mortgages! Being first time buyers we spent a lot of time trawling through the wide variety of cheap mortgages on offer, some were good and some just appeared cheap before you included the setup cost etc.

How mortgages work

A mortgage is kind of just like any other loan the main difference is is that you are lending the money and using your property as the collateral. For example the bank can be safe in the knowledge that if they lend you £200,000 then your house is worth that amount so if something goes terribly wrong and you couldn't pay your mortgage (which it wont unless you lend more than you can afford and don't take out payment protection!) then the value of the house would cover the cost of the money lent.

So here is the nitty gritty, say you wanted to lend £100,000 and the property you want to costs £100,000 then you would need a 100% mortgage, e.g you needed to lend 100% of the value of the house. If the property you wanted to buy was worth £200,000 and you only needed to lend £100,000 (generally applicable to remortgages )then you would be taking out a 50% mortgage, e.g lending only half the value of the house. Lending a lower percentage of the value of the house will generally give you a better rate of interest on your mortgage which we will come to in a moment.

The interest on your mortgage is one of the crucial factors which will determine what you pay on what you have lent, if we use the £100,000 example as a figure we can find out what we would be paying back on different interest rates. Currently (October 2007) here in the UK the average interest rate fr a 100% mortgage is about 7% this means if we borrowed £100,000, each year we would pay 7% in interest which is £7,000 just for the privilege of being lent all the money. This is where the different mortgage types come into effect, if you took out an interest only mortgage over say 25 years you would only ever pay off the interest on your mortgage, e.g £7,00 per year as in the above example. This means that after 25 years of paying £7,000 per year you would still owe the mortgage company the £100,000 borrowed. With interest only mortgages it is your responsibility to save separately over the length of the mortgage period to pay off the final balance.

Repayment mortgages work virtually the same as the above example as far as interest is concerned, the only difference is is that instead of just paying off the interest you pay a little extra which pays off some of the initial balance each year. So instead of just paying off the interest of £7,000 per year you would pay a little extra probably £8,000 per year. £7,00 would pay the interest chargeable on the mortgage and the extra £1,000 would pay off some of the initial balance. So after 1 year you would only owe the bank £99,000. This is where it gets a little complicated, now you would only pay interest on £99,000 instead of £100,000 as you have paid off some of the initial balance meaning that the interest chargeable for the second year would be £6,930, thats £70 cheaper than the previous year meaning as you continue to pay £8,000 per year toward your mortgage each year (£6,930 in interest and £1,070 off the balance) you are paying less interest and paying more off the balance until eventually the initial balance is fully payed off!

So those are the two basic types of mortgage, now well look at the different types of interest rate schemes you can choose from. The lower the interest the less money you will pay on what you are lending, there are several schemes which are available. A fixed interest rate is a rate which can be fixed for a set period of time meaning you know exactly what interest you will be paying for that set period of time. The other scheme is a tracker, this basically means that the interest rate on your mortgage is linked to the national bank's base rate which means that you interest rate can go up as-well as down a few percent above the banks base rate. Some months you could be paying more interest and others you could be paying less!

So there you have it, mortgahes in a nut shell, all you need to do is combine the different components of the mortgage and decide which fits your budget best, Interest only witha fixed rate for several years or a repayment tracker, or even an interest only tracker. Once you break these down into their component parts it diest seem so terifying at all. I am not a qualified adviser so plese consult a financial adviser before making any decisions you are not sure of.