'Can I just have a normal one please?'

Having trouble choosing between a five year fixed-rate, discounted, pension mortgage and a variable rate, interest-only Pep loan spread across several funds? Richard Phillips reviews the many different ways you can pay for a home these days
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The Independent Online
The First signs of innovation in the mortgage market came in the mid-Eighties with the arrival of the so-called centralised lenders. And what a disaster that turned out to be.

Centralised lenders are mortgage providers who do not have a branch network. They included foreign banks eager to snatch a chunk of the burgeoning British mortgage market and a few specialised lenders set up especially to compete with the building societies and high street banks.

It all sounded fine on paper but laxer lending standards combined with the need for these new lenders to carve out market share led to inevitable hubris.

Centralised lenders were among the worst offenders at a time when borrowers ended up burdened by debts beyond their means - and then interest rates doubled. Without the cushion of cheap funds from retail deposits, these lenders were forced to raise interest rates faster than others. Many of their customers had weaker credit-ratings to begin with so losses were compounded.

All of which may be why the current frenzy of mortgage deals has a grim ring of familiarity about it. As then, it is the hunt for market share that is driving much of the current activity. Hopefully, however, the lessons from the debacle of the Eighties have not all been forgotten.

There have undoubtedly been some useful developments, such as the fixed- rate mortgage. This is of real practical benefit to borrowers - you are in a position to know precisely what your outgoings will be for the duration of the fixed-rate term which is very useful for anyone who likes or needs to budget ahead.

They are a relatively new innovation. This is because fixed-rate mortgages require fancy financial techniques, some relying on complex computer models, to ensure they return a profit for the lender even when base rates rise above the fixed rate.

Present fixed-rate mortgages range from 4.99 per cent for a one-year fixed rate with the Bristol & West including a 3 per cent cash back up to pounds 3,000, to 6.99 per cent for five years from the Abbey National for those borrowing less than 75 per cent of the purchase price. The deals on offer are constantly changing: a week rarely goes by without one of the lenders restructuring its interest rates.

THE BIGGEST decision to be taken by a borrower is how the mortgage is to be repaid. The choice is vast but can be broken down into two types: an interest only mortgage, and a repayment mortgage. In both cases you borrow the same amount and pay interest on the money you've borrowed but with an interest-only mortgage you do not repay the capital sum as you make your mortgage payments. Instead you pay this back in a lump sum at the end.

Interest-only payments are lower than with an interest and repayment loan, even when you factor in the extra cost of paying for an investment product. This is necessary to ensure you are in a position to repay the capital borrowed at the end of the mortgage term. You pay this separately, usually on a monthly basis, and the money is invested in equities and bonds. The idea is that it will have accumulated to the amount that you owe by the end of your mortgage term.

There are now three types of interest-only mortgages, each linked to a different investment vehicle: the endowment mortgage, the pension- linked mortgage and, most recently, the personal equity plan (Pep) mortgage.

Endowment mortgages have taken a drubbing over the last few years as it has become clear that they would be unable to live up to some of the projections made for them in the mid-Eighties. Returns of of up to 15 per cent are back in line with more modest historical trends. The "with profits" element of an endowment - the annual bonus allotted by the investment firm - have fallen to as low as 3 per cent in some cases.

But there is no evidence that any endowment scheme will fail to pay off the capital owed. And with endowments making up about 40 per cent of the market, they are extremely popular. However, endowment mortgages - and pension and Pep mortgages - all leave you faced with the uncertainty of a long wait before any capital is repaid. A lot can happen in 25 years. Death, divorce, children and unemployment can all send financial plans awry.

Set against this, the great attraction of a repayment mortgage is its simplicity. It is also more effective against the threat of negative equity. As you repay some of the capital each month, the loss you are exposed to if the value of the property falls is also reduced.

However, an interest payment only mortgage should provide a nice lump sum at the end of it, in addition to the repayment of the loan.

A difficult choice, perhaps. If it feels so you would be wise to obtain some advice. If you can't afford an accountant many lenders offer free advice which can be invaluable when it comes to deciding what is best for your individual circumstances.

Pension linked mortgages are most suitable for the self-employed and those without company pension schemes. They offer exceptional tax benefits. A private pension plan has the same tax relief benefits as an occupational scheme. If you are a basic-rate taxpayer then for every pounds 76 a month you pay in into your pension, the Inland Revenue pays in pounds 24 - the basic rate of tax. Of course the actual benefit to the investor is higher: 31 per cent, or 24 out of 77. With compounding on your side, it all adds up to a nice little earner.

But it won't automatically be the right choice for you. Mike Penn, financial services marketing manager at the Woolwich Building Society says: "It all comes down to your individual circumstances. We would not advise a pension linked mortgage for someone who is 25, for example, unless there was very good reason."

And you can only cash in ("commute", in the jargon) up to 25 per cent of your plan at termination to repay the mortgage, or you lose your tax relief.

A Pep mortgage also offers tax advantages - and greater flexibility that other options. Unlike an endowment or a pension plan where you have to - with rare exceptions - stay with the same investment company, with a Pep you can change fund managers, cash in your scheme or draw some money from it, as the situation requires. And you can invest up to pounds 6,000 a year to earn the maximum tax relief. You can have more than one fund manager and spread your money around, putting some into high growth funds investing in emerging markets, some into tracking the FTSE 100 index, and some into corporate bonds, for example.

A number of building societies offer Peps through their own in-house investment arm but you may prefer to adopt a more DIY approach. After all, building societies are yet to develop a reputation for being investment whizzes. This will, however, require a lot more input by you, to decide which funds to select, to monitor their relative performance, and to decide how best to spread your cash.

FINALLY, there are the deals on loans being offered by banks and building societies. These fall broadly into four categories, with various permutations: discounted mortgages; fixed rate mortgages; cashbacks, and the traditional standard variable rate product.

Discounted mortgages are where the rate is reduced for a year or two.

Cashbacks - often combined with other offers - are simply a means for the lender to build market share. They are giving away money, although they do usually come with some restrictions, such as being tied to the lender for a certain time.

And finally a new product from the Woolwich - a fleximortgage. This allows borrowers to take a payments break for up to eight months, up to a monthly maximum. The deal allows you to plan for a time when you may need to take a break, such as for a baby or unemployment.

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