A Guide To Stepped Mortgages

By: michael sterios

With interest rates on the rise property owners are searching for ways to save money on their mortgages. Monthly repayments have been steadily growing due to a gradual increase in the Bank of England base rate and those on variable rate mortgages are feeling the pinch.

With regards to interest rates, there are two types of mortgages - variable rate and fixed rate. The interest rate attached to variable rate mortgages, and therefore the repayments due each month, fluctuates with increases and decreases in the base rate. The interest rate attached to fixed rate mortgages, however, remains stagnant for a set period of time.

The trade off when fixing interest rates on mortgages, and therefore reducing risk, is that the fixed rate is generally higher than the current variable rate offered on the same products. Mortgage applicants must therefore choose between the two options based on whether they wish to take on the risk or pay a potentially higher interest rate that will not budge.

In the wake of increasing interest rates, fixed rate mortgage have become popular amongst UK home owners who live in fear of further rises. For many, this may seem like the only option they have to potentially save money on their mortgages.

There is, however, another option, in the form of stepped mortgages.

Stepped mortgages are a hybrid between variable and fixed rate products. The offer the borrower a low interest rate to being with and have future rate agreed to at the outset.

For example, stepped mortgages may offer a borrower a 5% interest rate for the first year rising to 6% for the second year and 7% for the third year. The interest rates are agreed upon at the beginning of the term of the loan and the changes will occur regardless of what the base rate is doing.

This has the effect of reducing the borrower's monthly repayments on the stepped mortgages during the first year, and ensures that future rises in the interest rate do not come as a surprise and can therefore be budgeted for.

Despite this, borrowers should be aware that stepped mortgages usually come with tie-in periods and hefty early repayment charges. The borrowers will therefore be locked into paying the higher interest rates several years into the term of the loan or face the prospect of paying a large fee if they choose to remortgage to another product.

However if the borrower remains disciplined and takes advantage of the lower interest rates during the first few years of the mortgage term they might be able to pay off some of the balance of their home loan. This would provide a reduction to the amount of interest payable on the mortgage. When the higher interest rates take effect the actual amount of interest payable each month will not increase as much as it would have if no payments were previously made to the balance of the loan.

Stepped mortgages are therefore a product which can help home buyers to pay off their home loan sooner.

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