Repayment Mortgages
With a repayment mortgage (sometimes also known as a capital and interest mortgage), the borrower makes monthly repayments to the lender and each monthly amount consists partly of interest and partly of capital repayment: the higher the interest rate (for any given mortgage amount and term), the higher the monthly repayment.

The repayment is calculated in such a way that, provided interest rates do not change, it will remain the same throughout the term of the mortgage. If interest rates do go up or down, the repayment is increased or decreased, or alternatively the mortgage term can be extended or shortened.

Because the repayment remains unchanged (ignoring fluctuations in the interest rate), the relative proportions of capital and interest vary throughout the term: for example, at the beginning, when very little capital is repaid, the repayment is mainly interest: then, as more capital is repaid, the interest proportion of the repayment grows less and less.

The result is that the amount of capital outstanding decreased by smaller amounts each month at the start compared with towards the end of the term.

Two important factors that should be noted are:

The mortgage will be repaid at the end of the term, provided that changes in interest rates have been allowed for and that all repayments have been made when due;

If the borrower, or the breadwinner in the borrower's family, dies before the end of the mortgage term, the repayments will have to be continued or the outstanding loan repaid. Separate life assurance is required to cover this eventuality.

Interest only mortgages

In the case of an interest only mortgage, the monthly payments made to the lender are solely to pay interest on the loan. No capital repayments are made to the lender during the term of the loan and the capital amount outstanding, therefore, does not reduce at all.

The borrower still has the responsibility of repaying the amount borrowed a the end of the term, and this is normally achieved through the borrower making regular payments to an appropriate savings scheme, although the loan might be repaid out of other resources, eg from the proceeds of a legacy. The main schemes used for this purpose are: endowment assurances of various kind; individual savings accounts (ISAs), and personal pension or stakeholder pension plans.

Borrowers should be made aware of the risks involved in taking out an interest-only mortgage, in particular that repayment of the mortgages is dependent on the performance of an investment plan achieving a predetermined rate of return. If this is achieved, then the borrower will be left with a shortfall: the value of the policy or plan will be lower than that of the total debt.

Variable rate
A variable rate is the basic method of charging interest, with monthly payments going up or down without limit as interest rates change. One disadvantage is that borrowers cannot easily predict the level of future payments, which can cause budgeting problems.

Discounted mortgage
A discounted mortgage takes the form of a genuine discount off the normal variable rate (eg 2% off for three years). It is not a deferment of capital or interest payments. There is usually a restriction on how soon the mortgage can be repaid, or a penalty for repaying within a certain period.

Fixed rate
With a fixed rate mortgage, the borrower is able to ‘lock in’ to a fixed interest payment for a specified period, usually between one and five years. At the end of the period, the rate reverts to the lender’s prevailing variable rate. This scheme is popular with first-time buyers and others who want to be able to budget precisely. There is often an arrangement fee.

Capped rate
An interest rate might have an upper fixed limit, known as the cap. The lender’s normal variable rate will apply to this type of mortgage, but it will be subject to the capped rate. Should the variable rate exceed the cap, the borrower will still pay not more than the capped rate. If there is also a fixed lower limit, it is known as a cap and collar mortgage.

Base rate tracker mortgages
As the name suggests, base rate tracker mortgages are linked to the base rate set by the Bank of England. The base rate is reviewed once a month and reflects the cost of borrowing money from the Bank of England. Base rate tracker mortgages give the borrower the certainty that their payments will rise and fall in line with base rate changes. It should be noted that most lenders offering this type of mortgage do charge a premium above the base rate. A typical example would be a borrower being charged interest at 0.95% above the base rate.