There are multiple ways interest can be charged to the mortgage account for both types of mortgage (repayment and interest-only). For example, some lenders charge interest on an annual basis, some on a monthly basis, and some on a daily basis.
Generally speaking, it is the lender who decides how interest is charged, although this can vary between different mortgage products or services.
Mortgage lenders will generally offer a range of different interest rate options or ‘mortgage products’, such as fixed rate and variable rates, as well as the facility to defer the interest or take an interest payment break or ‘holiday’.
Notes on Technical Terms
- Monthly payments rise and fall in line with changes in interest rate.
- It is hard to predict what future payments will be, therefore making budgeting quite difficult.
- The Interest rate is discounted from the standard variable rate (SVR).
- There may be penalties for early repayment.
- The Interest rate is fixed for a specific time period (typically between one and five years) then reverts to the variable rate (SVR).
- This makes it easier for borrowers to budget.
- There may be a significant standard arrangement fee, and penalties or restrictions on switching to another lender.
- The interest rate is variable within a specified upper limit (the cap).
- This allows borrowers to budget within set parameters.
- Borrowers can benefit from falls in interest rates (as far as any collar limit set, i.e. a minimum level).
- Products that also have a specified lower limit are called ‘cap and collar’ mortgages.
- Interest moves up and down in line with changes in bank rate.
- Please be aware that a tracker mortgage is not at the same rate as the bank rate – the lender’s rate will be a little higher in most cases.
- The flexibility to overpay, underpay and/or take payment holidays without incurring penalties or charges.
- Interest is usually calculated on daily basis.
- Options can include current account and offset mortgages.
- Repayment mortgages with lower payments to start, during which capital is not repaid.
- These are suitable for borrowers keen to keep outgoing payments low in the early years.
- Higher payments will be required after that initial period to make sure repayment of capital is taking place.
- The interest payments are deferred until later down the line.
- This suits borrowers who might expect their income to increase over the term of the mortgage.
- Not suitable for those who borrow a high proportion of the property value, because of the ongoing increased risk of ‘negative equity’.
These mortgages give the borrower some flexibility to change their monthly payments to suit the person’s ability to pay, as well as the opportunity to pay off the mortgage more quickly. Although there is no exact or precise definition of a flexible mortgage, it is generally considered that such a product should offer the following basic features as standard:
- The facility to make overpayments at any time without incurring an early repayment charge;
- The interest is calculated on a daily basis;
- There is a facility to underpay, but only within certain limits set by the lender;
- The facility to take a payment holiday, again within boundaries laid out from the start.
Two key benefits of these features are as follows:
- The mix of a daily interest calculation and occasional/regular overpayments will result in considerably less interest being paid overall, and the mortgage term being reduced.
- The ability to reduce monthly payments (or suspend them completely) for a limited time will be helpful for someone experiencing temporary financial problems. In these circumstances, a borrower may be able to borrow back overpayments made earlier in the term.
Many lenders are now offering flexible mortgages with a fixed, discounted or capped rate for an initial, interim period. Early repayment charges do not usually apply to these products, but an arrangement fee may be chargeable and, in some cases, a particular insurance product must be purchased from the lender at the same time.
Most flexible mortgages will allow the borrower to draw down further funds as and when required, although the lender will have set a limit on total borrowing at the commencement of the agreement.
Flexible mortgages involve a much simpler administrative process than is usual when dealing with further advances. The way in which the mortgage deed is generally worded for flexible mortgages is such that all additional funds withdrawn, within the limit on total borrowing, will automatically take priority over any other subsequent or further charges registered against the property.