Different Ways Of Paying Interest On A Mortgage

In theory, mortgages should be simple. You borrow money from a lender to buy a property, and you pay the lender back over a period of time with interest.

If only it were that simple. It doesn’t take long to work out that mortgages aren’t that simple, and with lenders continually updating their mortgage ranges, it only gets more complicated.

The way you pay interest back on your loan can vary depending on the lender and the type of mortgage you get. Here is a list of the most commonly used methods of paying interest on a loan:

Fixed Rates

The interest rate is fixed for the period agreed, usually for 2 to 5 years. For example, if you get a fixed rate of 5.5%, you’ll pay 5.5% for 2 years, without any change in rates.

You need to be careful with fixed rate deals; eventually the fixed rate will expire, and then you’ll be placed on the lenders variable rate, which is usually north of 7%. Once the variable rate kicks in you’ll be paying a lot more than you’re used to. It’s usually a good idea to remortgage before you’re placed onto the variable rate, so it’s important to be aware of any possible remortgaging penalties.

Fixed rate plans are ideal for budgeting or if you think rates might increase; you won’t feel the sting. However, you won’t benefit if interest rates fall.

Variable Rates

Being on a varibale rate means interest rates can vary through the year. The rates typically vary when the Bank Of England changes the base rate. However, the rate changes can depend on what type of variable mortgage plan you have. For example, if you have a variable tracker mortgage, the rates will track the Bank Of England’s base rate and change accordingly, hence “tracker”. Standard variable mortgages will vary at your lenders discretion, so even if the Bank Of England drops their rates, it doesn’t necessarily mean your lender will follow suit. Whatever kind of mortgage you start with, it is likely to change to a standard variable rate at some point.

The advantage of variable rates is that you can reap the rewards of lowering interest rates, as it can reflect on your monthly payments. However, similarly, it can work against you if the Bank Of England increase the base rate.

Capped Rates

The maximum rate of interest that you pay is fixed for a certain time period. If interest rates rise above your capped rate, your payments will stay the same. If interest rates drop, then your repayments will also drop to reflect the lower interest rate.

Cash Back deals

This is when lenders offer money back if you take out a particular mortgage deal. However, be warned, cashback mortgages may be weighed down with hefty penalty charges if you later want to switch lender. If you think something is too good to be true, then it usually means it is, especially with mortgages.

Discounted Rates

Under this type of mortgage the borrower is offered a discount off the lender’s variable rate. The rate paid will fluctuate in line with changes in the variable rate. The discount applies over a set term.

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