Mortgage types

The UK mortgage market is one of the most innovative and competitive in the world. Unlike some other countries, there is little intervention in the market by the state or state funded entities and virtually all borrowing is funded by either mutual organisations (building societies and credit unions) or proprietary lenders (typically banks). Since 1982, when the market was substantially deregulated, there has been substantial innovation and diversification of strategies employed by lenders to attract borrowers. This has led to a wide range of mortgage types.
As lenders derive their funds either from the money markets or from deposits, most mortgages revert to a variable rate, either the lender's standard variable rate or a tracker rate, which will tend to be linked to the underlying Bank of England (BoE) repo rate (or sometimes LIBOR). Initially they will tend to offer an incentive deal to attract new borrowers. This may be:
• A fixed rate; where the interest rate remains constant for a set period; typically for 2, 3, 4, 5 or 10 years. Longer term fixed rates (over 5 years) whilst available, tend to be more expensive and/or have more onerous early repayment charges and are therefore less popular than shorter term fixed rates.
• A capped rate; where similar to a fixed rate, the interest rate cannot rise above the cap but can vary beneath the cap. Sometimes there is a collar associated with this type of rate which imposes a minimum rate. Capped rate are often offered over periods similar to fixed rates, e.g. 2, 3, 4 or 5 years.
• A discount rate; where there is set margin reduction in the standard variable rate (e.g. a 2% discount) for a set period; typically 1 to 5 years. Sometimes the discount is expressed as a margin over the base rate (e.g. BoE base rate plus 0.5% for 2 years) and sometimes the rate is stepped (e.g. 3% in year 1, 2% in year 2, 1% in year three).
• A cashback mortgage; where a lump sum is provided (typically) as a percentage of the advance e.g. 5% of the loan.
To make matters more confusing these rates are often combined: For example, 4.5% 2 year fixed then a 3 year tracker at BoE rate plus 0.89%.
With each incentive the lender may be offering a rate at less than the market cost of the borrowing. Therefore, they typically impose a penalty if the borrower repays the loan within the incentive period or a longer period (referred to as an extended tie-in). These penalties used to be called a redemption penalty or tie-in, however since the onset of Financial Services Authority regulation they are referred to as an early repayment charge.
"Self Cert" mortgage
Mortgage lenders usually use salaries declared on wage slips to work out a borrower's annual income and will usually lend up to a fixed multiple of the borrower's annual income. Self Certification Mortgages, informally known as "self cert" mortgages, are available to employed and self employed people who have a deposit to buy a house but lack the sufficient documentation to prove their income.
This type of mortgage can be beneficial to people whose income comes from multiple sources, whose salary consists largely or exclusively of commissions or bonuses, or whose accounts may not show a true reflection of their earnings. Self cert mortgages have two disadvantages: the interest rates charged are usually higher than for normal mortgages and the loan to value ratio is usually lower.
100% mortgages
Normally when a bank lends customer money they want to protect their money as much as possible; they do this by asking the borrower to fund a certain percentage of the property purchase in the form of a deposit.
100% mortgages are mortgages that require no deposit (100% loan to value). These are sometimes offered to first time buyers, but almost always carry a higher interest rate on the loan.
Together/Plus mortgages
A development of the theme of 100% mortgages is represented by Together/Plus type mortgages, which have been launched by a number of lenders in recent years.
Together/Plus Mortgages represent loans of 100% or more of the property value - typically up to a maximum of 125%. Such loans are normally (but not universally) structured as a package of a 95% mortgage and an unsecured loan of up to 30% of the property value. This structure is mandated by lenders' capital requirements which require additional capital for loans of 100% or more of the property value.