What are the mortgage basics - Stage 2 Select the method of paying interest?

There are three basic choices of how to pay interest: Variable rate, where the rate can go up or down, fixed rate, where the rate is fixed for a pre-determined period, and capped, where the monthly payments have a maximum for a guaranteed period.

The variable rate mortgage alows the interest rate can go either up or down. This means that the interest rate could stay the same for many months, or may change on numerous occasions over the course of a few months. In general, the standard variable rate (SVR) charged by the mortgage lender will mirror the Bank of England Base rate, so you should monitor that rate to suggest what your mortgage rate may be.

You should be wary of a lender with an unusually high SVR. This is especially so, in view of the incentives offered by borrowers to encourage them to take on a variable rate mortgage.

- They could offer a discount for a few months up to a period of a few years. At the end of the period you will revert to the SVR, which can be a shock.

- They may offer cashback, a sum of money towards the fees or charges you have to pay out to get a mortgage. It is likely you'll pay for this with a higher SVR.

- You may be offered specific subsidies for fees or charges.

A Base Rate tracker mortgage is a newer variable rate mortgage, where interest charged is linked entirely to the Bank of England Base Rate, set each month on the first Thursday by the Bank of England's Monetary Policy committee. The rate will usually be at a set level above the base rate (e.g. 1%) for the life of the mortgage.

With a fixed rate mortgage, you are guaranteed to pay a certain level of monthly payments for an agreed period. You can thus budget with a certain amount of confidence as you are protected against rising base rates. The period in which your rate is fixed could be up to 25 years, and as low as 6 months, after which you revert to the standard variable rate for the mortgage.

A capped mortgage is a combination of fixed and variable mortgage. There is a maximum rate over which you will not be charged for a certain period. If the SVR falls below the cap, your payable rate follows it down

You should always ask about redemption penalties should you take on a discounted, fixed or capped mortgage. Redemption penalties charge you for paying off or moving mortgages, and whilst it could be during the deal, it may be after the deal has ended.

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© AskFinancially.com 2008

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