Ten Steps to Financial Freedom

Make It Home Sweet Home

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 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 one thing we cannot stress enough is the importance of shopping around for the best possible mortgage for your needs.

Repayment mortgages vs. interest-only mortgages

With mortgages, you must pay off the interest on the loan each month, but as for the loan itself, you have a few 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 - the challenge with this type of mortgage is that at the end of the term you'll need a lump sum to pay off the capital.

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. Differentiating by the way interest is calculated, the most popular mortgages tend to be variable rate, fixed rate, discount and tracker, capped rate, and offset mortgages:

  • Variable rate mortgages are up to your bank or mortgage provider. They set a rate on their own, usually heavily influenced by the Bank of England's base rate, and raise, lower, or freeze this rate as they choose.
  • Fixed rate mortgages are fixed for a set time, so you know exactly what to expect. It's a smirk of satisfaction for you if your lender's variable rate rises above your fixed rate, but if it falls, your mortgage provider is laughing all the way to the bank.
  • 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 follow the interest rate of an independent body, usually 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 or minus anything between 0.5% and 2%.
  • 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.

Buying to let

Buying to let is a popular investment option, but from a mortgage perspective, being a landlord requires a bit more planning than your average homeowning situation. If you need a loan to fund the purchase, you will need a buy to let mortgage. These are designed to give more favourable and flexible terms, with the main difference being that most lenders won't just take your salary into account, but will include potential rental income from the property when assessing loan eligibility.

Foolish tips for mortgage holders

Whatever your mortgage, remortgage! Most lenders reserve their best deals for new customers, which means you can often get a better deal by remortgaging every few years. While remortgaging can take some time, with rates for new mortgages up to two percentage points lower than the typical standard variable rate, remortgaging could save you hundreds of pounds a year.

Overpay your mortgage each month. If you can do it without penalty, overpaying even £50 a month could save you thousands of pounds in interest in the long term and take years off the term of your mortgage, bringing forward the day when you own your home outright.

A final note on mortgages

Be a savvy mortgage shopper! Look at the Annual Percentage Rate (APR - also known as the overall cost for comparison), how often interest is calculated (daily is better than monthly and monthly is better than annually), how long any early repayment charges will keep you locked in for, and if you can overpay without incurring penalties.

Go to step six

Next up: sailboats and Argyle knits. Part of financial freedom is retiring when you want to, with the means to do what you want to do. All it takes is a little careful planning and disciplined saving.

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