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A mortgage is a loan, secured on the value of a property, which you pay back over a period of time. "Secured" means you must make payments as agreed or the provider has the right to sell your property in order to recover their money.

Paying your mortgage back

There are two ways to pay off your mortgage (the 'capital'), as listed below. You can also use 'mix & match' by using a combination of repayment and interest - only to repay your mortgage. Repayment mortgage (also called a Capital-and-interest loan) - this type of repayment method is also known as a Capital & Interest mortgage - your monthly repayments pay off the interest and some of the capital borrowed each month. This is the only method that ensures your mortgage is totally paid off by the end of the term - as long as you keep up your payments.

Interest-only mortgage

This is where you only repay the interest on your mortgage each month, so you'll need some sort of investment plan to pay off the capital, e.g. a pension, an endowment policy, an ISA or other long term investment plan. When your investment matures, you cash in the plan and use it to pay off your mortgage loan. You are responsible for the repayment of the capital when the mortgage reaches the end of the term, and you may want to seek professional advice on the investment.

Types of mortgage products

Standard variable rate (SVR)
The lender's main rate. 'Variable' means it goes up and down broadly in line with general interest rates.

Fixed rate
The rate of interest on your mortgage is fixed for a set period of time regardless of whether the Bank of England Base Rate or the lender's Standard Variable Rate changes. Most mortgages have rates that change over time - and repayments that go up as well as down. This can make budgeting difficult, but a fixed rate mortgage can help.

Fixed rate mortgages are suitable for those who prefer to know exactly what their monthly outgoings will be. There may be minor variations in your monthly payments to cover insurance, but your mortgage interest rate will stay fixed no matter what happens to mortgage rates elsewhere. An Early Repayment Charge may apply if the mortgage is repaid during the fixed period. Remember, if interest rates fall, you may miss out on a reduction in your monthly payments.

Capped rate
This is a variable rate that goes up and down in line with interest rates generally but never rises above a set level (the 'cap'). Useful because it helps you to budget and still allows you to get the benefit of any falls in interest rates.

Capped and collared rate
This is a variable rate that goes up and down in line with interest rates but will only go between two set levels (the 'cap' and 'collar' rates). Useful because it will only go between these two rates.

Tracker
With a tracker rate mortgage, the rate of interest you pay is a set percentage above the Bank of England base rate for the term of the loan. The percentage is agreed at the start, and your repayments will go up or down in line with changes to the base rate.

Discount rate
The rate of interest you pay is set at an amount below the lender's standard variable rate (SVR), and the rate you pay moves up or down in line with any changes to the SVR. This type of loan is cheaper than Standard Variable Rate at the start of your mortgage and allows you to take advantage of any interest rate cuts. But if interest rates rise, your monthly payments go up.

Most people find that buying a home -and especially their first -leaves them financially stretched. With the extra expense of decorating and furnishing, anything that keeps costs down in the first years can be a big help. That's exactly what a discount mortgage does. The discount you enjoy in the first few years of your mortgage can mean a big saving, and the discount usually means you are tied into your mortgage during the discount period. So, if you change your plans and need to repay your mortgage during the discount period, you will have to pay an Early Repayment Charge. However if you simply want to move house, you can usually take your mortgage with you.

Cash back
You receive a lump sum or percentage of your loan in cash when you complete your mortgage

Flexible
This type of mortgage is designed to accommodate your changing financial needs. It may allow yout o overpay, underpay or even take payment holidays. You may also be able to make penalty free lump sum payments.

Please note: If you're a graduate from University, most banks will offer you a special mortgage - usually if you've graduated within last 5 years.

Charges - APRs

What you pay for a loan, such as a mortgage, can be expressed as an 'Annual Percentage Rate' or APR. The APR is a way of comparing the total cost of different loans over the whole term, say, 25 years. The APR takes into account:

• The interest you must pay
• Certain other charges you must pay - for example, an arrangement fee
• When and how often you pay the interest and charges

You do not need to know how to work out an APR. The important thing is that APRs show the cost of borrowing on a standard basis. So you can compare one APR with another. It might seem obvious but a loan with a lower APR is generally cheaper than a loan with a higher APR. Lenders must show the APR in most advertisements and in quotes for mortgages. The APR also lets you compare the cost of a mortgage with other types of borrowing.

The APR for a mortgage does not always tell you the whole story because some charges are not included - for example, premiums for buildings insurance that you must take out through the mortgage lender to get a special deal. Charges that you only might have to pay are not included - for example, an early repayment charge if you pay off part or all of the mortgage in the early years or before the end of its term. If you have an interest-only mortgage, the APR does not include the monthly payments you make to any investment plan that you intend to use to pay off the amount you have borrowed.

Get the Keyfacts about the mortgage

You'll get a keyfacts document when a lender or mortgage broker gives you information about a particular mortgage and that information is tailored to you (for example, based on the amount you want to borrow). They must give you one whenever you ask for one, whenever they recommend a particular mortgage for you and always before you apply for a mortgage (except for buy-to-let mortgages).

Use the APR
In adverts for loans, such as mortgages, you may see a percentage figure called the APR. This stands for 'Annual Percentage Rate'. This is not an interest rate but a figure which represents the total charge payable each year for a loan. The important thing is to use the APR to compare costs when you are shopping around for a loan. You do not need to know how to work out an APR. You should also consider other aspects of the loan, as well as the APR, before deciding whether a particular loan is right for you.

What is a keyfacts document?
Firms must give you a keyfacts document as it is important. You can recognise it by this sign: about this mortgage. It summarises the important features of the mortgage and must be clear, fair and not misleading and will be presented in a standard way, so you can easily check the cost and terms of the mortgage and compare it with other similar mortgages.

Next steps
The lender will assess your application by checking that you are who you say you are, that you can afford the mortgage and value the property. Once all this is done, you will get a mortgage offer document which will include an updated version of the keyfacts illustration (KFI). Use this to compare with the original KFI. This is your final chance to check you are happy with all the terms and conditions of the mortgage. If anything is not clear or if there are differences between the KFIs, talk to the lender. Make sure you read and understand it before signing up for a mortgage. Ask the lender to explain anything you don't understand.

Charges - early repayment charges

Early repayment charges are made when you pay off (redeem) all or part of your mortgage before the end of the mortgage term. They may be charged in the following situations:

• You switch to a different lender
• You switch to a better deal from your existing lender
• You pay a lump sum off of your original loan
• Move to a cheaper property and reduce the size of your mortgage
• You sell up and pay off your entire mortgage

You should check your mortgage key facts document carefully to see if early repayment charges can be made and, if so, under what circumstances. If you are happy to agree to a mortgage that ties you in for a set number of years, check whether early repayment charges apply after the initial deal ends.

How big are the charges?
They are typically worked out as a percentage of the amount you repay, a percentage of the amount you borrowed or a number of months' interest. Whatever method is used, it can lead to a large charge. For example:

	Example 1	Example 2
Pay off whole mortgage outstanding	£50,000	£50,000
Redemption charge	5% of mortgage paid off	6 months interest at 5.75%
You pay	£2,500	£1,438

Charges - other points to bear in mind

Other features of a mortgage that affect the amount you pay include:

Repayment mortgage
- How often interest is calculated by the lender?
With a repayment mortgage each payment you make consists of interest and some of the capital (the loan). If interest is calculated monthly it takes account of the capital you have repaid up to the last month. This reduces the amount of interest you pay on the loan compared with mortgages where the interest is calculated yearly.

- How your payments are treated if you pay off a chunk of your loan or regularly pay extra each month
With some mortgages, overpayments only reduce the mortgage balance once a year so they take a long time to affect your interest payments. Other mortgages deduct overpayments from your balance straight away, which means you get the benefit immediately.

Some mortgages are marketed as 'flexible mortgages' (also called 'Australian mortgages'). They are designed to allow you to make extra payments whenever you want to and benefit immediately. Some also let you reduce your payments or take a payment holiday. Another variation is the 'all-in-one mortgage' where you have your current accounts and savings with your mortgage lender. Your mortgage interest and monthly payments are then worked out based on your mortgage balance less the balances in your current and savings accounts. The higher your savings, the less you pay for your mortgage.

Switching your lender

You do not have to stay with the same mortgage lender. At any time, you can pay off your existing mortgage by taking out a replacement with a new lender. This is called 'remortgaging'. The main reason for remortgaging is to reduce the cost of your mortgage. Lenders often bring out attractive new deals for new borrowers but leave existing borrowers paying higher interest rates. Another reason is to have a more flexible mortgage that, for example, lets you overpay or miss some payments. The disadvantages of remortgaging are:

• If you have a mortgage which ties you in for a particular time you may have to pay an early repayment charge when you pay off the old mortgage. But you can avoid this if you wait until the end of the period during which these rates are payable
• You may have to pay valuation and solicitor's fees to get the new loan - though sometimes the new lender will pay these for you
• The lower interest rate on the new mortgage may only be for a limited period

You need to weigh up whether the likely savings on your monthly payments compensate for the costs of remortgaging. There may be a minimum amount you can borrow - for example, £15,000 or £25,000. Lenders usually limit the maximum you can borrow. This will be based on the lender's assessment of how much you can afford in monthly mortgage payments and the value of the property you intend to buy.

You cannot usually borrow more than the value of the property. If the amount you borrow is more than, say, 90% of the value of the property (in some cases if you borrow more than 80%), you may be charged a 'high-lending charge'. This buys protection for the lender - not you - against the value of the home falling to less than the mortgage. If that happened and you could not keep up the mortgage, the lender would sell your home to get its money back. But the sale proceeds would be less than the mortgage. The insurance would pay the lender the amount of the shortfall. The insurer might then try to recover the pay-out from you. If you cannot prove your earnings - for example, you have recently started your own business and don't yet have any audited or HM Revenue and Customs accepted accounts, you may be limited to a smaller choice of mortgages and have to pay a higher than usual interest rate. The same applies if you have a bad credit record - if you have a persistent history of debts, you might not be able to get a mortgage at all. Some mortgages are aimed at particular groups - for example, first-time buyers.

Access and affordability

Lenders will make an assessment of your ability to pay the mortgage based on your salary or other income and your outgoings. Taking out a mortgage is one of the biggest financial commitments you can make, both in terms of the amount you borrow, and the length of time it may take to repay it. You may be able to afford your mortgage today but what would happen if..

Your income falls?

Your income could fall if:

• you lost your job, or had to take a drop in income
• you or your partner stopped work to have a child or to look after a dependant or
• you became ill and couldn't work

Interest rates rise?

• Your mortgage payments to your lender could go up (or down) if interest rates change. Mortgage interest rates are related to the interest rate set by the Bank of England and lenders usually apply some or all of any change to your mortgage
• Unless your mortgage rate is fixed for the full term of your mortgage, this will affect you
• Often, special rates are for a set period so when they come to an end your payment will change - it could be much higher

Although interest rates have been stable over the past few years, this could change. In the past, interest rates have risen from 7.5% to 15% in just a few years. Interest rate rises could increase your monthly payments considerably, making it difficult for you to afford them.

Affordability and protection

The monthly payments for a large loan may stretch your budget in the early years. But you should look not just at what you'll have to pay now. Will you be able to afford the payments in future - for example, when a low discounted rate comes to an end or if interest rates rise? Of course, some things can't be predicted. If you became ill and couldn't work or you were made redundant, you might not be able to keep up the payments. You can guard against this by taking out 'mortgage payment protection insurance' (MPPI), which would pay the interest on your mortgage for up to one or two years.

It is a good idea to take out MPPI, or some other kind of income protection insurance, because state benefits do not normally cover mortgage interest during the first nine months you are out of work. But make sure the insurance cover is suitable to you and your circumstances - especially if you are self-employed or have a pre-existing illness. A particular mortgage deal may require you to take out insurance - for example, buildings insurance or mortgage payment protection insurance - through the lender. You should be cautious about this type of deal, as the lender's insurance can often be expensive. There are plenty of good mortgage deals that do not attach strings like this.

Example of how much you can afford to borrow

You need to take account of what happens when special deals, like discounts, come to an end. Suppose you borrow £102,500 as a 25-year repayment mortgage and there's a special deal that gives you a discount of 4.5% off the standard rate of 7%. So you pay interest at:

• 2.5% in the first year; and
• 7% a year in subsequent years (assuming your lender's standard rate stays at the current level)

The lender gives you a quotation. It shows that:

• In year 1 your monthly payments will be £463
• From year 2 onwards, the monthly payments rise to £733

Terms

When you ask for information about a particular mortgage you should be given a 'Keyfacts illustration' which summarises the main features of the mortgage. The illustration is personal to you, for example, based on the amount you want to borrow. It uses a set format so you can easily compare one mortgage with another. The mortgage offer will also include keyfacts information, setting out for example:

• The type of mortgage - repayment or interest-only
• The amount of the loan
• The term (number of years)
• Details of any special deal, such as a cashback or discounted rate
• The amount you must pay each month
• Details of any early repayment charges
• Details of any insurance you must buy from the lender

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Source: www.fsa.gov.uk, www.alliance-leicester.co.uk