Mortgage Products and Repayment Methods
An adviser must be able to compare products and explain the trade-offs in plain terms. This topic covers how a loan is repaid (capital-and-interest versus interest-only and the vehicles behind interest-only), the main interest-rate options (fixed, tracker, discount, capped and the standard variable rate), flexible features such as offset, and the arithmetic CeMAP loves to test — loan-to-value, monthly interest and the shape of a repayment loan.
Repayment methods: capital-and-interest versus interest-only
There are two fundamental ways to structure repayment. Under a capital-and-interest ('repayment') mortgage each monthly payment covers the interest due plus a slice of the capital, so provided payments are maintained the balance reduces to zero by the end of the term — the loan is guaranteed to be repaid. Because early payments are dominated by interest on a large balance, only a small part goes to capital at first; as the balance falls the interest portion shrinks and the capital portion grows, so the debt clears slowly at first and faster later. Under an interest-only mortgage the monthly payment covers only the interest; the capital does not reduce and the full amount borrowed remains outstanding at the end of the term, to be repaid from a separate strategy. For the same loan, rate and term, a repayment mortgage has a higher monthly payment than interest-only (because it also repays capital) but leaves nothing outstanding at the end — the certainty is the reason it is the default recommendation for most residential borrowers. A 'part-and-part' mortgage combines the two: part of the loan is on repayment and part on interest-only, so only the interest-only portion needs a separate repayment plan.
Interest-only repayment vehicles
An interest-only mortgage is only responsible if there is a credible plan to repay the capital, and advisers must be able to describe the common vehicles. A stocks-and-shares ISA or general investment plan aims to build a tax-efficient lump sum, but its value is not guaranteed and can fall. A traditional endowment mortgage pairs an interest-only loan with a with-profits or unit-linked endowment life policy intended to grow to repay the capital and provide life cover — many older endowments fell short of their targets, which is why they are now rare and treated cautiously. A pension-linked interest-only mortgage plans to repay capital from the tax-free lump sum available when a personal pension is taken. Other acceptable strategies can include the sale of a second property or other reliable assets. What is not acceptable as a repayment strategy is simply relying on future house-price inflation. Whichever vehicle is used, the risk is investment risk — the fund may not reach the required amount — so the plan must be realistic and monitored.
Interest-rate options: fixed, tracker, discount and capped
The interest charged can be arranged in several ways. A fixed rate is set for a defined period (commonly two, three, five or ten years), giving payment certainty regardless of what happens to market rates; at the end of the fixed period, unless the borrower acts, the loan usually reverts to the lender's standard variable rate. A tracker rate is a variable rate that follows an external benchmark — typically the Bank of England Bank Rate — at a set margin above it, so it moves up and down automatically with that benchmark. A discount rate offers a set reduction off the lender's own standard variable rate (SVR) for a period; because it is linked to the lender's SVR rather than an external index, the lender can move the SVR (and hence the paid rate) at its discretion. A capped rate is variable but cannot rise above a stated ceiling (the cap), giving protection against rate rises while still benefiting if rates fall; a 'capped-and-collared' product also has a floor (collar) below which the rate cannot fall. Distinguishing a tracker (external benchmark) from a discount (off the lender's own SVR) is a classic exam point.
The standard variable rate, collars and reversion
The standard variable rate (SVR) is the lender's own default variable rate, set at the lender's discretion; it is the rate most borrowers fall onto when an introductory deal ends, and it is usually higher than the deals on offer, which is why advisers prompt clients to review and remortgage before reverting. A 'collar' is a floor on a variable or tracker product below which the interest rate will not fall even if the benchmark drops further, protecting the lender's margin. Understanding reversion matters for suitability and for the Consumer Duty's fair-value lens: a headline two-year fixed rate that reverts to a high SVR may cost more over time than a slightly higher rate with a better reversion, and the adviser should look beyond the initial rate to the total cost, fees and early repayment charges.
Flexible features: offset, current-account and flexible mortgages
Flexible products let borrowers use the mortgage more actively. An offset mortgage links a savings account (and sometimes a current account) to the mortgage; the credit balances are set against the mortgage balance so interest is charged only on the net difference — a borrower with a £200,000 mortgage and £50,000 in a linked savings account pays interest on £150,000. This is especially attractive to a higher-rate taxpayer with significant savings, because the effective 'return' on the savings is the mortgage interest rate saved, free of income tax on interest, and it can shorten the term or reduce payments. A current account mortgage (CAM) goes further by merging the mortgage and current account into a single blended balance, whereas a standard offset keeps the accounts separate but linked. Flexible mortgages typically allow overpayments, underpayments and payment holidays, and often calculate interest on a 'daily rest' basis, meaning interest is recalculated daily so overpayments reduce the balance — and the interest charged — immediately, which benefits the borrower compared with annual-rest calculation.
The arithmetic: LTV and interest calculations
CeMAP tests simple, exact calculations. Loan-to-value (LTV) is the loan as a percentage of the property value: LTV = (loan ÷ property value) × 100. On a £250,000 property with a £200,000 mortgage, LTV = (200,000 ÷ 250,000) × 100 = 80%. Where the lender's valuation is below the purchase price, the LTV is calculated on the lower figure. A maximum-LTV rule sets the minimum deposit: on a £400,000 property at 90% maximum LTV the maximum loan is £360,000, so the smallest deposit is £40,000. Monthly interest on an interest-only balance is the annual interest divided by twelve: monthly interest = (balance × annual rate) ÷ 12. On a £150,000 interest-only loan at 4.8%, annual interest = 150,000 × 0.048 = £7,200, so the monthly payment = 7,200 ÷ 12 = £600. On a £200,000 offset with £50,000 offset at, say, 4%, interest is charged on £150,000 = £6,000 per year, or £500 per month. Remember the structural point behind the numbers: for the same loan a repayment mortgage always costs more per month than interest-only because it also repays capital, but it clears the debt.
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