Mortgage calculator: is it better to rent or buy?

Taking out a mortgage was once as simple as heading down to a local building society and having an interview with manager.

Now, instead of going straight to a building society, you might instead trawl two or three price comparison sites, chat to a couple of lenders, and also visit a few banks, before choosing your loan.

Get your choice right, and you could save yourself hundreds of pounds a month in interest. Get it wrong, and you could make life much harder than it needs to be to meet your repayments.

The credit crunch explained

• How to improve your credit rating

• How to choose a credit card

• How to pay off your debts

BACKGROUND

• How to remortgage

• How to buy a house

• How to release equity from your home

BACKGROUND

• The beginner's guide to mortgages

• How to buy to let

The basics

Mortgages are a loan secured against your property, which means that if you do not keep up repayments, the lender could request that you give up your home so that it can sell the property and make its money back.

Lenders will usually offer you an initial "deal", which will consist of a competitive interest rate over a set period of time. Once that deal period comes to an end, the lender will put you on what is called the Standard Variable Rate. This is usually much higher than the initial deal you were on.

Avoiding the high SVR repayments is the reason that people switch mortgage deals and lenders so often, although sometimes SVRs can be more competitive than some of the deals on offer, and come with fewer restrictions, so it is important to check.

The Bank of England base rate gives an indication of the cost of borrowing in an economy. Although most mortgage rates do not match the base rate exactly, they do tend to go up and down roughly in line.

Tracker rates go up and down exactly in line, pegged at a rate a set amount above or below the base rate, so for borrowers with these deals, movements in the Bank of England base rate are more crucial.

Fixed rates

These are deals where the interest rate is fixed at a certain level for the duration of the deal. Most lenders offer a range of 2, 3, 5, 7 and 10 year fixed rates, although it is possible to fix for as long as 25 years. Usually, the longer you fix for, the more expensive the rate.

The advantage of having a fixed rate is that you know what your monthly repayments will be, giving you security and the ability to budget.

The disadvantage is that if interest rates do fall, you miss out on the opportunity to make savings.

Fixed rates are determined by swap rates, which are the money markets where lenders buy what they call "tranches" of funding. Fixed rates were worst hit by the credit crunch, because lenders stopped lending to each other.

Tracker rates

As mentioned above, these "track" the Bank of England base rate, by a certain number of percentage points above or below.

On these deals, your repayments come down if the base rate goes down, and up if the base rate goes up. However, some lenders have a rule in their mortgage contracts allowing them to freeze tracker rates when the base rate falls below a certain level.

When economists expect the base rate to come down, you can expect that tracker rates will usually carry a slightly higher premium to cover the risk to the lender.

Variable rates

Unlike trackers, these can go up or down by more or less than movements in the base rate and at different times.

As well as the standard variable rate, you can get discounted variable rate deals. These often offer big discounts initially, making them look more attractive than other tracker and fixed rate deals, but then borrowers risk above average rises should interest rates begin to creep up.

Offset mortgages

Offsets are an ingenious concept that only work if you have a lot of savings. They reduce the amount of interest you owe on your borrowings by "offsetting" them against your savings balance. So if you had a mortgage worth £100,000 and savings of £20,000, you would only be charged interest on £80,000.

Interest rates on offset deals are typically higher than on standard mortgage deals, so the general advice is that they are only really worth considering if you have savings worth at least 10 per cent of your mortgage.

Current account mortgages, such as the One Account, follow a similar logic, with your current account balance being offset against your mortgage. The main downside to this is that you have to get your head around seeing a balance that is always a minus number, such as -£98,546, which some people find a little scary.

Fees

When you take out a mortgage, it is not as straightforward as simply paying interest on a loan, there are all sorts of other costs to consider. These include arrangement fees, which lenders charge just for setting up the mortgage, valuation fees, to cover the cost of valuing your property, and legal fees, to pay the solicitor for doing the necessary legal paperwork when you take out a deal.

Potential costs do not end there. If you redeem the loan before the tie-in period is up, you will probably have to pay an early redemption fee, often about 3 per cent of the loan. This is another reason why many borrowers prefer shorter-term deals.

Many lenders also charge exit fees, of around £200 to £300. However these have been heavily criticised for being unfair, and in cases where you have been charged a fee in excess of what you signed up to, lenders will refund you. See our guide on how to claim.

Overpayments

Most mortgage deals allow you to over-pay by up to 10 per cent of the balance each year. If you want to pay off more than that, you should opt for a deal with more flexibility.

Some deals are fully flexible, allowing for overpayments, underpayments, and payment holidays, for months when you are tighter on cash. These deals often suit the self-employed, because of the erratic nature of their incomes. However they come with a premium for the privilege.

"Drop-lock"

These deals are relatively new in the mortgage lexicon. They begin as a tracker, but allow borrowers to "drop" into a fixed rate if interest rates fall and the borrower thinks they would like to remain on that rate. The idea is that if you think interest rates have fallen as far as they are going to go, or are in danger of going up again, you still have the option of fixing.

The term

Mortgages are usually repaid over a term of 25 years, because, traditionally, spreading the repayments over this term brings them to a more affordable level. However, it is possible to extend or reduce the term, depending on the lender's conditions.

Extending the term reduces monthly repayments but increases the overall amount of interest you will have to pay. Reducing the term means you will have to increase your repayments, but will be mortgage-free sooner.

However not all mortgage deals offer the facility to change the term. If they do, you may have to pay a premium on the rate.

Arrears

Failing to keep up with repayments is called arrears. Your lender will normally take your property back off you if you are more than six months in arrears on your loan, and if you do not have an alternative repayment plan in place.

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Five websites

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What Mortgage Magazine

Mortgage broker: John Charcol

Mortgage broker: London & Country