Step 5: Make It Home Sweet Home

Should you rent a home or buy one? Many of our European friends are more than happy to do the former throughout their lives, however we Brits seem to be cut from a different cloth.

Generally we would say owning your own home is a good thing. In order to make a profit, most landlords need to charge more in rent than it costs to finance a property. So therefore it will usually make sense to own your home and cut out the middleman.

That said, we are not in the camp of those who regard renting as ‘dead money’. There can be times when renting is a more sensible choice, like when you are moving around from job to job, or you are sharing a house in order to save money for a deposit.

But sooner or later, most of us buy a home, which means sooner or later, most of us need a mortgage. As far as borrowing goes, mortgages are usually considered acceptable debt: mortgage providers are prepared to lend people money at a reasonable rate, and it is usually a far cheaper way of borrowing than almost any other form of debt, because it is secured against a property.

As with all financial products, the cost can vary a lot for what is essentially the same thing. So shop around to make sure you’re getting a good deal, and consider using a mortgage broker as they may have access to deals that aren’t available direct from a mortgage provider.

Repayment vs. interest only

With mortgages, you must pay off the interest on the loan each month, but as for the capital value of the loan itself, you have two choices:

  • With a repayment mortgage you can pay off the loan gradually: part of the cash you pay each month covers interest on the loan, and the rest pays off a portion of the capital sum you borrowed.
  • With an interest-only mortgage, you will have the amount you borrowed outstanding for the whole term, as you only pay off the interest each month. This type of mortgage was much more popular in the 1980s and 1990s, but these days there are concerns that people who took them out back them haven’t put enough aside to pay off the outstanding capital at the end of the mortgage term.

Different types of interest rates

Once you decide whether you’re going with a repayment mortgage or an interest-only mortgage, the next step is to look at the kind of mortgage you want, which is all about interest rate:

  • Variable rate mortgages are up to your bank or mortgage provider. They set a rate on their own, with any movements up or down usually influenced by the Bank of England’s base rate.
  • Fixed rate mortgages are usually fixed for a set number of years. Many people try to second-guess what might happen to mortgage rates in order to work out whether they would be better off with a variable or a fixed rate. Tempting as it may be to think you might be able to outsmart your mortgage lender, we’d say the main thing that should influence whether you choose a fixed-rate mortgage is whether you’d find it to difficult to cope with significantly higher monthly repayments.
  • Discount mortgages offer a percentage discount off the lender’s standard variable rate, which means your monthly payments move up and down with the lender’s normal variable rate, but you enjoy a discount over a set time. The trick with these is getting a discount mortgage that doesn’t lock you in after the discount ends, as you’ll want to remortgage as soon as it does.
  • Tracker mortgages are usually directly linked to the base rate set by the Bank of England: when the base rate changes, the tracker mortgage changes automatically. Interest rates on tracker mortgages are usually set at the base rate plus anything between 1% and 3%.
  • Capped rate mortgages ensure there is a ceiling to the interest rate you will pay over a given period of time. As with fixed rate mortgages, if your lender’s variable rate rises above the capped rate, you benefit, but unlike as with fixed rate mortgages, if it falls below the capped rate, you pay what everyone else pays. The downside of capped rate mortgages is that they tend to have higher interest rates than fixed rate mortgages – the price of enjoying a fixed upper limit on your mortgage payments.
  • Offset mortgages allow you to contribute your savings towards your mortgage, without losing access to the funds themselves. The more you have in your savings account, the less interest you have to pay on your mortgage, which helps you repay your mortgage faster and more cheaply. Offset mortgages tend to be best for people with volatile incomes or significant savings.

Don’t forget to remortgage

Whatever your mortgage, remortgage on a regular basis, or at least look around to make sure you are not paying too much over the odds.

Most lenders reserve their best deals for new customers, which means you can often get a better deal by remortgaging every few years. You may have to pay an arrangement fee, and other sundry costs, but even taking these into account, given the sizable sums involved, switching mortgage deals can save a decent amount of cash.

Next up, pensions and retirement.