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Choosing the right mortgage
Taking out a mortgage is for most people the biggest financial commitment they are likely to make so it's important to get it right. There are literally thousands of mortgage lenders and even more mortgage and related products on the market so choosing the right one can be a daunting prospect.
But despite the huge choice, there are only a few different types of mortgage and the differences are easy to understand. Broadly speaking mortgages fall into two main categories: fixed rate mortgages and adjustable rate mortgages.
A fixed rate mortgage is so-called because the interest rate repayable is fixed. Consequently the monthly repayment remains fixed for the term (duration) of the loan. Often a mortgage will have a fixed rate for an initial period, perhaps five or ten years and then will revert to a variable rate.
A fixed rate can prove advantageous because it removes the uncertainty of not knowing what the monthly payments will be in the future. It enables the borrower to forecast and budget precisely.
Furthermore if the a fixed mortgage rate usually becomes easier to pay as the long term effects of inflation and house price increases mean that the monthly repayments become significantly less in real terms and the value of the property increases.
However if the fixed rate was set in unfavourable economic conditions, where the base interest rate is high, the borrower stands to lose out if at a later time, interest rates are reduced as his fixed interest rate would still be high. Banks and mortgage lenders on the whole set fixed rates at a higher level than the average variable rate predicted for the future period to offset the potential risk of losing out if base level interest rate rises higher than anticipated.
In an adjustable rate mortgage the mortgage interest rate is pegged to a market index so fluctuations in the base rate will be passed on to the borrower's monthly repayments. This is in effect passing the risk of higher future base level interest rate rises onto the borrower since no matter what the level the base rate is, the bank's margin will be the same. Adjustable rate mortgages therefore usually carry a lower interest rate and are popular among shorter term borrowers.
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