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Different types of residential mortgages

Different types of residential mortgagesThe two main types of mortgages include repayment and interest only, although different lenders have come with different names to their various loan packages.

Repayment Mortgage

This is by far the most popular and straightforward type of mortgage available. The borrower mortgages his property in return for a loan which is repaid through monthly installments. Every month as the borrower makes his monthly payments he is not only repaying a part of the borrowed money, but also an interest on the loan. At the end of the term, when the loan has been paid in full, the mortgage on the property is discharged. However, if the borrower wishes to sell his property before the mortgage is discharged, he can do so and pay-off the remainder of the mortgage from the proceeds of the sale and any money over and above this belongs to the borrower.

Interest-only Mortgage

In an interest-only mortgage, the borrower pays back only the interest on the loan. The whole of the capital is paid at the end of the loan term through a special endowment policy or a separate investment plan that lets him pay-off the capital amount.

The best thing about the mortgage is that the monthly repayment is low. But the problem with these mortgages is that one cannot always guarantee that the investment plans may generate enough funds to pay off the entire capital amount. Sometimes, borrowers enter into a combined mortgage, wherein a part of the loan is interest only and a part of it is repayment.

The Interest Rate

Irrespective of the type of loan chosen, the borrower may have to choose a method by which the interest is set. He can either choose a fixed interest rate or a variable mortgage rate. The standard variable mortgage rate is based on the lender’s basic mortgage rate and reacts to the rise or fall of the UK base rate set by the Bank of England.

Borrowers who would like to keep their monthly repayments stable, especially in the initial period of the loan can choose a fixed rate of interest. A borrower can also opt for a capped mortgage which ensures that there is a maximum limit beyond which the rate of interest cannot be increased. There also exists tracker mortgage where the rate of interest is set at a percentage above the one set by the UK base rate set by the Bank of England. In all instances, the interest rate reverts to the standard variable mortgage rate once the fixed, capped, or tracker interest rate period ends. But if the borrower chooses to repay the loan within the special interest rate period, he may have to pay a special ‘redemption penalty’ for doing so.

Payment Protection

Sometimes it may happen that the borrower or a joint borrower dies, suffers from an illness, or becomes unemployed during the term of the loan. Usually under such circumstances, the burden of the loan becomes immediately payable from the estate of the deceased. But if the deceased borrower was the main or sole bread-earner for the family, it causes a strain on the existing family members to cope with the repayment. Thus, to protect their investment, it is common for lenders to insist that the buyer takes out a mortgage protection policy. This policy guarantees payment in event of any unfortunate incident such as death, accident, illness, or unemployment. If the property is jointly owned, it is important that all co-owners take out this policy, so that even if one co-owner is unable to repay, the burden does not fall upon the person who is alive.

Islamic Mortgage

Islam forbids its followers from charging interest on loans. Some loan schemes that are Sharia compliant, avoid charging interest. Under this scheme (also called Murabaha) the bank buys the property (intended to be purchased) on behalf of the buyer and then resells it to the borrower at a higher price. The price is then paid to the bank in installments over a fixed period of years.

There is also the Ijara and the Diminishing Musharaka scheme where the bank purchases the property and leases it to the buyer in return for a rent. And at the end of the lease, the property is transferred to the buyer.

Photo courtesy: roarofthefour



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