We explore the different types of mortgages, interest rate options and what to do if you're having trouble paying off your mortgage.
Types of mortgage
There are 4 basic types of mortgage.
Revolving-credit facility: This operates like a large overdraft, secured by the mortgage over your home. Interest applies whenever the account is overdrawn – and the account can be overdrawn at any time up to the maximum of the mortgage.
Revolving credit is flexible and works well for disciplined borrowers. But offsetting the flexibility is the temptation for some people to never quite pay down the balance. If you want the flexibility of a revolving-credit mortgage without the temptation, ask your lender or broker about your options. Some possibilities are a revolving-credit mortgage with a reducing balance (where the credit limit available reduces over time), or a flexible table mortgage that allows you to "redraw" some of what you have repaid.
Table mortgage: This is the most common form. The repayments do not alter over the life of the mortgage. At the beginning, most of each repayment is interest, by the end you're mostly repaying principal.
Reducing mortgage: On each repayment, you repay the same amount of principal. This reduces the interest charge each time, so each repayment is less than the previous one.
Interest-only mortgages: When you pay interest only, monthly repayments are financially more digestible. But you'll have to start paying off the mortgage at some point. And, unless house prices head upwards, you're not
building up equity in your home. The risk is that if property prices fall, your property will be worth less than what you paid for it. If you have to sell, you could end up deeper in debt.
NB: For clarity, these descriptions assume interest rates do not change.
Interest rate options
There are 2 main types of interest-rate (and 2 hybrids).
Floating: The lender can change the interest rate on the mortgage whenever they choose. A floating-rate mortgage offers you wide scope to change your plans too. You can make extra repayments, increase or decrease repayments (subject to some limits), or repay the mortgage early, without copping penalty fees.
Fixed: The lender cannot change the interest rate for a certain period, such as a year. This gives you certainty, and floating rates are usually higher than fixed rates prevailing at the same time. This explains why fixed-rate mortgages are very popular these days. But with a fixed-rate mortgage you will often face a penalty if you want to change the conditions.
Capped rate: A compromise is a capped rate. If floating rates rise above the cap, the cap doesn't follow, but if floating rates drop below the cap, the capped rate drops too.
Discounted rate: Another alternative to a fixed-rate deal is to have a discounted rate. This guarantees you stay below the floating rate – whichever way it moves – for the length of the discount, provided you have all of your loan in it.Source: www.consumer.org.nz