Understanding mortgages in the UK: The different kinds explained

A loan secured by a property is known as a mortgage. But there is plenty more to know than that!

11:30 18 December 2013

A mortgage is an arrangement where one borrows money in order to be able to buy a property. In such an agreement, the lender holds a lien (security interest) on the property until the money is repaid by the borrower. The mortgage is repaid over time with interest and once the loan is fully repaid the lien is released and the property is fully owned by the borrower. Mortgage repayment is made up of two parts, the capital – the amount borrowed – and the interest – the cost of borrowing the money.

You are responsible for making the agreed payments because a mortgage is a legal agreement. If you do not pay as agreed, the mortgage lender can repossess the property. Make sure you make the right decisions about how much to borrow, for how long and from which lender.

Ways to pay:

• Interest only - In order to have low monthly payments you can agree to only pay the interest on what you have borrowed each month. At the end of the mortgage term, the whole amount borrowed becomes due and you have to have arranged a way to pay it back. This can be done by paying into another investment such as an endowment policy, ISA or pension giving you the means to repay the full amount at the end of the term. Many lenders now limit the size of the loan to a percentage of the property value such as 75% of the property value.

 

• Repayment (capital and interest) – In order to have everything paid off at the end of the loan term you can pay a portion of the capital (amount borrowed) as well as the interest (cost of borrowing) each month.

 

• Part and Part mortgage – this means you choose to pay part interest and part repayment each month. At the end of the term, you will still need to repay some of the capital but it will be less than if you only paid interest.

The interest only option will cost less each month than the repayment option but you should remember to include in your budget the amount needed for the cost of the investment it will take to be able to pay back the capital at the end of the loan term.