Mortgages - Flexible or Non-Flexible?

The UK mortgage market is one of the most dynamic and competitive in Europe. To keep abreast of all the changes, new product launches and new lenders takes some doing.

One of the most recent innovations is the flexible mortgage. Let's look at the difference between this and the traditional mortgage, and then we'll look at which type is best for you:

Flexible Mortgages

Allows you to overpay, underpay and take payment holidays. The main benefit is that you will be charged daily interest. Some lenders allow you to offset your deposit savings against your mortgage balance, meaning you will pay less interest on the debt. You'll also pay no income tax on your savings, which saves you time as you don't need to declare it on your tax return.

NOTE: Not all 'flexible' mortgages offer these facilities. Some lenders market their products under the flexible banner, but are surprisingly inflexible in practice.

Traditional Mortgages (Non-Flexible)

You pay a set amount to the lender every month. They may calculate your interest annually (many traditional mortgage companies now charge on a daily interest basis as well), meaning that as your balance reduces during the year (if it's a repayment mortgage) the interest you pay will be on the balance that applied at the start of the calendar year. 

The facilities that you can access on a flexible mortgage are generally not available.

NOTE: Several lenders will allow you to pay back 10% of the original loan balance at any time, but check the small print to see if this will benefit you or the lender the most (eg if the loan is on an annual interest basis you will not benefit until the next calendar year).

The BIG question is 'Which one is best'?

I've spoken to many clients who automatically think that the flexible route will be best for them. Perhaps they've read an article or had a discussion with a colleague.

The ONLY way you can make this kind of decision is to analyse the numbers. Let's look at an example, comparing a flexible deal with a traditional mortgage. These deals are current at the time of writing (July 4, 2006).

The loan size is £300,000 over 20 years, on a capital repayment basis. I've ignored any fees associated with setting up the mortgage.

Traditional: 4.37% 2 Year Tracker

On this deal the monthly payment is £1877. Over a 2 year period the amount payable is £45048.

Flexible: 4.69% 2 Year Tracker

On this deal the monthly payment is £1928. Over a 2 year period the amount payable is £46272.  

The difference is £51 per month, or £612 pa.

The question is, how much money do you need to offset against your flexible mortgage to make the flexible deal worthwhile?

If we use a deposit savings rate of 5% gross AER on a sum of £20,500 you'd receive £1025 in interest. After 40% tax this reduces to £615 pa, more or less the difference between the two mortgage annual difference amounts.

Therefore, you'd need £20,500 to offset against your flexible mortgage to achieve equilibrium.

REMEMBER:

After the two year period, the tracker rate will increase to 5.7% for the flexible deal and 5.89% for the traditional deal.
 
The Key Considerations

Many borrowers become comfortable using the features of flexible mortgages. That's all very well, but bear in mind that if you are not going to utilise the flexible features in full (particularly offsetting) you may be
better off remortgaging every two years or so to a traditional type deal and pay a lower rate.      

YOUR HOME MAY BE REPOSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE. The FSA does not regulate all types of mortgages.