What is a Mortgage?

Writen by on 26th Jan 2013

Mortgage Types

When referring to the word mortgage nowadays, people often mean it to represent a mortgage loan. A mortgage loan is a loan taken out through a bank, or any other financial institution, to secure a property. As with all loans, mortgages (mortgage loans) are provided by a financial institution with an interest rate. This is applied by the lender at a rate that they deem represents the risk involved for them.

  • In order to understand some of the jargon associated with mortgage lending, some definitions of the regular mortgage terminology have been created.
  • A mortgage loan is the most popular way worldwide in which people buy or secure residential or commercial property.
  • The property is the actual residence that the borrower is trying to secure or buy with a mortgage.
  • The purchaser of the property can also be referred to as the borrower as they are borrowing the mortgage loan in order to buy the property.
  • In turn, the institution providing the mortgage can also be referred to as the lender. For example this could be a bank or a building society.
  • The lender applies interest to the mortgage loan by way of a financial charge for letting the borrower use their money.
  • This mortgage is made different to other types of loans by a repossession clause in which they can legitimately seize the property from the borrower for example, if they cannot keep up with their mortgage payments and therefore no longer afford to buy the property.
  • The above are the main features of a typical mortgage, although other factors such as where the property is located, the history of the property or the lenders individual terms can also help define the mortgage type.


Money House

Mortgage Rates Money House

Interest only Mortgage

An interest only mortgage is a mortgage that is taken out to simply pay the interest from the loan and nothing from the capital. Whereas a capital repayment mortgage is taken out in order to pay both interest and capital from the mortgage.

Interest only mortgages are largely used alongside an investment plan. This way a regular monthly payment is made in order to pay off the interest from the loan, alongside regular separate payments to an investment plan. Therefore, when the mortgage matures, there is a separate amount of money available to repay the full capital from the mortgage. This type of mortgage is referred to as an investment-backed mortgage, an endowment mortgage in the case of an endowment policy being used, and in the same trend (related to the type of plan used), a Personal Equity Plan (PEP) mortgage, Individual Savings Account (ISA) mortgage or pension mortgage.

These types of mortgages used to provide great tax advantages however nowadays they do not. They are also classed as higher risk mortgages as you are effectively gambling on the hope that the investment is enough to clear the mortgage.

Another gamble used by interest only mortgage borrowers is that the property market will increase enough in order for the mortgage to be paid back. On this basis, mortgage lenders will provide interest only mortgages if they feel that the area with which you buy, is projected to have a sufficient enough house price rise.

Capital and Interest

A repayment mortgage is the most used way of repaying a mortgage loan. This is done by making regular payments of both capital and interest from the loan over a certain period of time. These payments are calculated using time value of money formulas. Other details such as the amount of interest that you pay can be subject to other factors such as how interest is compounded. This can be done daily, yearly or semi-annually; or by way of being calculated as part of a 360 day year. Other factors such as prepayment penalties may also factor as a feature.

The length of the mortgage loan can also vary. The common practice for the UK is for a mortgage to be taken out for 25-30 years as a maximum; however, shorter periods (for example 15 years) are quite common and longer mortgages (anywhere up to 50 years) can also be arranged with the lender.

Capital and interest mortgages are named as so as each monthly payment made, pays off both capital and interest from the loan. The amount of capital and interest that is paid by the monthly payments often differs throughout the term of the loan. For example, at the beginning period of the mortgage most borrowers are paying off little capital and more interest. However, towards the end of the loan this switches to the other way around. In order for the lender to ensure that the loan is cleared by the end of the term, payments are decided at the beginning with a clear date at the end at which the mortgage loan is to be cleared by.


Mortgage types in the UK

All mortgages in the UK are funded by organisations such as banks, building societies or credit unions. The government does not contribute to any of the lending. This ensures that the UK mortgage market is thus very competitive and forever changing tactics in order to secure business from its prospective borrowers. This has resulted in many types of mortgages being made available.

Most of these banks, building societies and credit unions draw their money from money markets or deposits and therefore offer variable rates to their customers. These can be in the form of a standard variable rate set by the lender, or a tracker rate, (one that tacks the Bank of England base rate). Due to healthy competition between the lenders, pioneering incentives are always being created in order to appeal to borrowers to take up their particular mortgage loan. You may need more knowledge about mortgage, so please read all article of our website realestateadvertisingideas.org

Some of these deals are listed below:

Fixed rate. The interest rate stays the same for an agreed period ranging from anywhere between 2 and 10 years. Any term above 5 years tends to cost more to the customer, and this type tends to therefore be used less regularly than the shorter term alternatives.
Capped rate. This rate is comparable to the fixed rate in that the interest rate cannot rise above the capped rate, however it can vary below. This can also vary when a collar is applied, (this is where a minimum rate is applied). Like the fixed rate this type is offered for anything between 2 and 10 years.

Discount rate. This is where a discount is set on the standard variable rate over a period of time, typically 1-5 years, (for example a 1% discount for 2 years). The rate can also be stepped for example 2% in year 1, 1% in year 2, and so on.

Cashback mortgage. This is a lump sum normally provided as a percentage of the loan e.g. 5%
Just to confuse you more these rates are sometimes combined. As the lender is often supplying the customer with a rate below the market the mortgage loan will almost definitely include an early repayment charge.


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