Interest Rate Schemes

This article explains some of the different mortgage payment scheme variations available to the borrower

Interest Rates
 
These are simply how much you are going to be charged for your borrowing, and are an integral part in the lending industry.
We all want to borrow money and pay the least possible price for doing so.
 
Variable rate
 
This is subject to interpretation, and can vary according to lending criteria. It is basically the current rate at which the lender is charging all borrowers. The term variable comes from the fact that the rate will fluctuate with market forces.
 
Many lenders offer specialized schemes which offer short term incentives to stimulate borrowing. Some are described below
 
Fixed rate schemes
 
These are simply where the lender offers lending at a fixed rate over a certain period of time. After which the scheme reverts to the variable rate applicable at that time.
Pros and Cons, useful in times of high interest rates, will keep the borrower locked into a lower fixed rate for a period of time.
If rates are fluctuating quickly, the borrower could end up stuck in a scheme where the variable rate has dropped below that of the fixed rate.
 
Capped rate schemes
 
Similar in organisation to a fixed rate scheme but different in application. Basically the rate is set to a value below the variable rate. If the variable rate remains higher, then your payments stay at the capped rate. However if the variable rate falls below the level of  the capped rate. Your payments are adjusted to the lower level variable rate. Avoiding the pitfall of the fixed rate scheme. this is considered to be one of the best options available currently.
 
Deferred Schemes
 
Also referred to as an Adjustable Rate Mortgage: is a very complex animal which whilst it offers a degree of flexibility in early payments. It can cause serious issues in the later life of the loan if it is not fully understood. The following series of illustrations will show how it works.
For illustration purposes this example is worked over a 5 year period with interest rates rising at 1% per year. as per the graph below.

The graph shows payments rising over the first 5 years finishing at year 6 with the variable rate. During this time the borrower will have been paying interest at the rates quoted, BUT: The lender will have been charging interest at the variable rate. As per the illustration below.

As can be clearly seen, there will be a shortfall between the early payments and the rate charged by the lender. This shortfall will be added to the remainder of the loan when deferred period expires. As per the illustration below.

The difference between what was paid and what was actually charged is rolled up, or deferred, and added to the balance of the loan. Thus raising the original loan by that amount. It means the borrower ends up owing more than was originally borrowed. This is an extremely important thing to understand when embarking
on such a loan.

Article taken from the book
Key to the Door
a little guide on mortgage borrowing in the UK
by
Mark Reed

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