Mortgage Types

Mortgages should be straightforward - you borrow money to buy a house and pay interest on the loan. But after a few enquiries, you soon realise that it's not so simple after all. In a hugely competitive market, building societies and banks are continually updating and extending their range of mortgages. The list is already extensive enough to baffle all but the most determined. The most important points are how you pay back the capital you borrow and how you pay the interest on it.

Paying back the capital

You can either pay a little at a time as you go (repayment mortgage) or pay it all off at the end (Endowment, Isa and pension mortgages).

Repayment mortgages - Each monthly payment pays off a little of the underlying debt, as well as interest on the loan. At the end of the term the mortgage is cleared.

Endowment Mortgages - You use an endowment policy to provide life insurance and save funds to repay the loan at the end of the term (usually 20-25 years). If the investment performs badly, you could face a shortfall on your loan at the end of the repayment period.

Individual Savings Account (Isa) mortgages - These work on the same principle as endowments, but use an Individual Savings Account as the loan repayment method. If your investment performs badly you could face a shortfall at the end of the mortgage term.

Pension mortgages - Are similar to both ISA and endowment mortgages, but work on the basis that pensions (both private and company) provide tax-free cash on retirement. At the end of the mortgage term the loan is paid out of your tax-free lump sum. They are not often used as it can be risky linking pensions to other investments.

Paying the interest

You have to pay interest on any debt, and mortgages are no different. They differ only in the range of options offered.

Variable rates - This means you pay the going rate on your loan. The mortgage rate changes every time interest rates change or, as in most cases, the overall effect of any interest rate changes is calculated once a year and payments are altered accordingly. Whatever kind of mortgage you start with, it is likely to change to variable rates at some point.

Fixed rates - The interest rate is fixed for the period agreed - often two to five years. These are ideal for budgeting or if you think rates might increase. You do not benefit if rates fall, and will face penalties if you try to quit. Very low rates may tempt you, but they can be used to trap you into paying over the odds. See check how long you will have to stay with the lender before you can switch without penalty.

Capped rates - These are fixed, but if rates fall you pay the lower rate. Such deals can be a good buy for budgeting.

Cash back deals - This is when lenders offer money back if you take out a particular product.

Discounted rates - Under this type of mortgage the borrower is offered a discount off the lender's variable rate. The rate paid will fluctuate in line with changes in the variable rate. The discount applies over a set term.

The 10 key points

The government has given homebuyers a list of vital checks to help them find their way through the mortgage maze.

The government suggests buyers should ask these 10 questions before agreeing a mortgage with a lender.

• How much can I afford to borrow?
  This deals with such questions as "What will the cost be each month?" and "What fees will I have to pay?"
• How can I tell which mortgage rate is best for me?
• What is the best type of mortgage for me?
  This deals with how to understand the jargon, such as "What do fixed rate, variable rate, discounted or low-start, and flexible mean?" and "Will this mortgage suit my circumstances now and in the future?"
• How should I repay it?
  "Why are you trying to sell me an endowment policy, or a pension or an Isa?", "Why is it best for my circumstances?" and "What commission are you being paid?"
• Can I make lump sum payments to reduce the size of the loan?
• Are there any redemption penalties?
• Does this mortgage come with compulsory insurance?
• What other charges will I have to pay?
• What happens if I can't pay?
• What about the small print?