New Types Of Mortgage

So far we've looked at how you repay the capital and interest elements of a mortgage. In recent years though, new types of mortgages have become available which give us a few more options about how we can pay back the money we owe. These new mortgages can be grouped under three headings -- flexible, current account and offset.

Flexible mortgages

A mortgage is 'flexible' if it allows you to overpay and underpay when the need arises. Many standard mortgages will let you pay, say, 10% a year more than necessary. This means you can pay off the mortgage earlier than you expected, or you'll be allowed to take back some of your overpaid cash if you ever need to. In other words, you can take a 'payment holiday' should the need arise.

If this is the sort of deal you're looking for, you must ask your prospective lender how 'flexible' their particular mortgage really is. Some lenders will make you 'ask' for the money back, i.e. apply formally for the cash, while others will allow you to just help yourself to the surplus by underpaying.

The second and third types of new mortgage are a little trickier to get your head around. The basic principle is that they both combine the various aspects of your finances to save you interest. They do this by exploiting the fact that, in general, we get less interest on our savings than they we pay for our debts.

Current account mortgages

Current account mortgages work by turning your mortgage into essentially a very large overdraft. They allow you to set off all the savings you own against all the debts you that owe.

You're essentially combining all your debts with all of your income in a single current account. So every time your salary goes in you reduce the amount of the 'overdraft' and every time you take money out, the overdraft increases. This means you can overpay and underpay without being penalised for it. You simply have to repay the loan by a set time -- either by gradually reducing your borrowings to zero (just like a repayment mortgage) or by using a separate investment such as an ISA to repay your capital at the appropriate time (similar to an interest-only mortgage).

The great thing about them is that the interest charges on all your borrowings are at the cheaper variable rate for mortgages (say 6%) instead of the more common credit card rates (around 15%-20%). In order for this to save you money in the long run, you still need to pay off this non-mortgage debt as quickly as you would have done with a normal credit card or loan. If you simply add these debts to your mortgage and take 25 years to pay them off, rather than say 2 or 3, you'll end up paying far more interest when all's said and done.

You can also use your savings and your current account to offset your mortgage costs, thus paying it off more quickly. There are tax advantages too -- particularly if you're a 40% taxpayer. You don't pay any tax on the reduced interest you pay. So, rather than receiving, say, 3% on your savings after tax, you can actually 'save' interest of 6% on your mortgage.

Bear in mind that, with current account mortgages, you have to have a fair amount of financial discipline. You might find it rather too tempting to just blow your overpayments on that holiday in the Caribbean that you've always wanted, only to find you've been made redundant when you return. So be warned! Overpay when you can, but only take advantage of the facility to underpay when you absolutely have to.

Another factor to consider is that the rates on current account mortgages (and to some extent flexible mortgages) tend to be slightly higher than the best deals you can get for fixed-rate or discounted mortgages. So you may need to do some sums to see if you would be better off taking this route. If you have little in the way of savings or non-mortgage debt, then you'll probably be better off with a more traditional mortgage.

Offset mortgages

An offset mortgage is a close relative of the current account mortgage. The main difference is that your current account, savings account, loans and card debts are all kept in separate pots from your mortgage. You can then choose to set some, or all, of these accounts off against each other. So you could offset your savings and current account off against your card debts and mortgage, and therefore pay less interest as a result.

As with a current account mortgage, the interest you save on your debts will usually be greater than the interest you lose by offsetting your savings, especially taking tax into account. One difference with an offset mortgage though is that your monthly payment remains the same from month to month (unless interest rates change), so any interest earned on your savings in any given month is typically used to reduce your mortgage balance. With a current account mortgage you tend to only pay the net interest you're charged each month.

Are these mortgages for you?

These sort of mortgages are best suited to high earners or those with a reasonably high level of savings. You also need to run your finances in a disciplined manner. As mentioned above, these deals are rarely the cheapest available on the market, but many people will find that their flexibility more than makes up for this.