Introduction to mortgages

Because few of us are independently wealthy most of us take out a home loan - a mortgage - to buy our home. The rate of interest we pay for our mortgage is determined by base interest rates prevailing in the market. Base interest rates are set by the Bank of England.

Since the housing boom of the 1980s, the mortgage market is much more complex with a far wider choice of loan. If you are contemplating a first mortgage, a remortgage or a new mortgage if you are moving, bear in mind that you cannot rely on the lenders themselves to give you the best advice - they are not under any legal obligation to do so.

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How much can I borrow?

You may generally borrow three times the first income plus half of the second income, or two-and-a-half times joint income. Most lenders are prepared to lend you 95% of the property's value, but most charge less interest if you can pay a bigger deposit. Remember also that if you borrow more than 75% you may have to pay for insurance to protect the lender against you not paying the mortgage. You can get a 100% loan but they cost more. In general, you will be expected to have a deposit of between 3 - 10% of the asking price of the property you want to buy. Remember all the other expenses as well. Solicitor's fees, valuation, arrangement and mortgage indemnity costs soon mount up.

What choices are available to me?

Your basic mortgage choices are:

• a variable rate
• a fixed rate loan, usually higher than the variable rate
• a discount rate, which offers a discount on the variable rate

Many fixed rate loans and virtually all discounted offers have a sting in the tail in that you are required to stick with your mortgage lender’s variable rate for some years after your initial offer expires. This means you give up the right to shop around for another, cheaper deal unless you pay a stiff redemption penalty. Such penalties are designed to tie you to the lender after the cut-price period has ended. If you want to pay off all or part of your mortgage, you may face punitive costs which can be as high as six months' repayments.

Fixed rate mortgages fix your monthly repayment over a set period of time, regardless of what happens to interest rates. After the end of the fixed rate period, your mortgage cost will revert to the lender's Standard Variable Rate. Discount rate mortgages peg the interest rate you are charged to a fixed amount below the variable rate. If the variable rate rises, so will yours, and likewise if its falls. This offers some protection from the threat of rising interest rates.

How do I pay my mortgage back?

Your basic choice is between a straightforward repayment mortgage or an interest-only mortgage with some form of investment attached to it which will grow to pay the loan off at the end of the term. If you want the potential risk and reward of an investment linked mortgage it makes no sense now to take out an endowment policy. There is no tax relief on the life assurance part of the policy - that was scrapped more than twenty years ago - and the income return on your funds will have been taxed. It may make more sense if you want to tie your mortgage to an investment to consider an ISA mortgage. There is more flexibility in an ISA than there is in an endowment policy. You will lose far less of your investment by cashing in early - there are no penalties with ISA plans - and, of course, they are free of capital gains tax and income tax.

Endowment mortgages
If you already have an endowment mortgage and you are moving, it’s generally not a good idea to surrender your endowment policy. You'll be unlikely to get back anything like the return you should. What you can do is take the endowment policy with you and apply it to part of your second mortgage. Many lenders will now offer a split mortgage on a part-repayment, part-interest only basis. Or you may wish to take an interest only mortgage and cover part of it with your endowment policy and the rest with an ISA.

Flexible mortgages
In recent years, a new form of mortgage deal has appeared in the market. The flexible mortgage allows you to have one account which combines a home loan and a current account into one. So, if you take out say a £75,000 mortgage, and then you win £10,000 on the premium bonds, you can simply, without penalty reduce the size of your mortgage. Flexible mortgages often come with cheque books attached. So conversely, if you suddenly need an extra £5,000, you'll be able to write a cheque and in the process increase the overall size of your mortgage to £80,000. Different lenders have different limits for the proportion of your mortgage to property value that you can have outstanding at any one time.

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Provided by www.moneyextra.com