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Last Updated: Thursday, 5 August, 2004, 16:16 GMT 17:16 UK
Mortgages: Changing to a better deal
By Louise Greenwood
BBC Radio 4's Money Box

Stressed woman
Switching mortgage does not have to be a stressful experience
One of the best ways to save money is to review your mortgage, but the mortgage market has literally thousands of products on offer, and choosing between them can be a bewildering process.

It has been estimated that up to half of all mortgages are stuck on the most uncompetitive home loan of all, the 25 year "standard variable rate".

By changing to a better deal you could save thousands of pounds and cut years off the life of your loan.

This Inside Money guide explains the various types of loans on offer, the methods of repayment, and advice on how to keep the cost of switching down.

Methods of repayment

With 6000 different types of loans on offer, the one you take will depend on your circumstances. Mortgages are split between "repayment" and "interest-only" deals.

An interest-only mortgage allows you to repay just the interest on the loan you take out.

You must also buy an investment product that will mature and allow you to pay off the lump sum you borrowed as well.

Interest-only mortgages were popular in the past especially in times of high interest rates, when borrowing money was more expensive. But they fell from favour after the endowment mis-selling scandal of the 90s.

Interest-only mortgages can be linked to ISAs, Peps, even pensions, but it is vital to monitor your investment, because if it does not grow enough to pay off the debt, you must be able to make up the shortfall or you could lose your home.

A repayment mortgage is considered to be safer as your monthly payment chips away at both the interest and the capital sum. In the early years almost all of your repayment goes towards the interest on the loan but this decreases over time.

Types of mortgage

Once you have decided whether you would like a repayment or an interest-only mortgage you will be looking for a good interest rate, and different products set them in different ways.

Standard variable rate (SVR)

This roughly tracks the Bank of England's base rate, plus a premium of about 1.5%.

An SVR is almost never the best deal, but it is heavily marketed by lenders who make more money from this type of loan.

Fixed rate

This can be the most sensible option as repayments are fixed, usually for two, five or even 10 years.

While there is a danger interest rates could fall leaving you stuck on an uncompetitive deal, a fix does allow you to budget over a longer period.

Discount mortgages

These are popular with first-time buyers and those who need to keep costs down.

They offer a discount off the SVR, of about 1.5%. But they revert to the full SVR rate after an introductory period of about two years, meaning a big jump in repayments.

Discount mortgages often have clauses that lock in borrowers. These are called "redemption penalties" and will be discussed later.

Capped rate

This can also offer a lower interest rate and borrowers are protected from rising rates by a cap on how much interest you pay. Penalties often apply.

Offset

This kind of mortgage claims to save you thousands over the lifetime of the loan and works by linking your savings, current account and mortgage together.

You offset the debt on the mortgage against your savings and therefore pay less interest.

However, some experts say at least 20% of the value of the loan is needed in savings to make the arrangement worthwhile.

They are particularly suitable for self-employed people with erratic incomes and higher tax-payers who earn proportionally less on their savings.

Costs to look out for

About a third of all the mortgage business being written in the UK is people moving around to get a better deal.

But moving can be expensive so it is always worth asking your existing lender if they can make you a new offer.

It is more expensive for banks and building societies to attract new customers than to keep the ones they have got and they may offer you a rate they have not even advertised.

Penalties / redemptions

Lenders are none too pleased about borrowers shopping around to save money.

More of them are introducing so-called "redemption penalties" which are essentially a fine for pulling out of a mortgage ahead of time.

Redemption penalties can be equivalent to six months interest payments on the loan. So it is essential to check the small print on any mortgage offer before you sign.

Flexibility

Most mortgages allow you to make lump sum repayments of about 10% of the value of the loan each year.

With even the best savings rates at only around 5% (in August 2004) cutting a debt on which you are paying much more in interest makes good sense, especially if that debt is a big one.

Flexible mortgages also allow you to underpay, take payment holidays and even withdraw lump sums if you have enough equity.

Insurance

Beware lenders who ask you to take out expensive home insurance or life insurance policies with a mortgage.

You may also be asked to buy "mortgage payment protection" to cover you if you cannot work.

If you have to take out a big loan, say more than 90% of the value of the house, you could be charged a "mortgage indemnity guarantee" (MIG).

This covers the lender if your home is repossessed and sold for less than the value of the mortgage.

These bolt-ons could end up costing you more than you would be saving by moving to certain deals.

Additional fees

Independent research by the Consumers Association found that moving a mortgage of 100,000 can cost as much as 1,500.

With interest rates low, lending money is not as lucrative as it used to be. So banks and building societies are clawing back cash through hidden charges. These can be called "arrangement fees", "valuation fees", or "lenders fees".

Once these have been paid, it can be a long time before you recoup the cost of moving your mortgage at all.

The message is do your sums as a home loan that seems cheap can prove to be anything but.

Interest calculations

Many lenders will collect your repayments and only knock them off the mortgage itself at the end of the year, giving them a huge interest-free loan.

Many newer mortgage deals will calculate interest daily and are worth seeking out.

Remember that even small changes in interest rates can cost hundreds of pounds a year in mortgage repayments.



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