Home-loan outsiders cross the threshold

Flexible loans can save on interest and help the self-employed

The growing number of self-employed and contract staff is having a massive knock-on effect on the mortgage industry.

Flexible mortgages - currently offered by about 40 different lenders - are all the rage as borrowers seek to vary the amount they repay each month or even miss a payment or two. The degree of flexibility depends on the product you opt for, but in general they are much less rigid than the traditional mortgage.

One of the attractions of a flexible mortgage is the savings to be made on the interest you pay. Traditionally interest is calculated on an annual or monthly basis, but more lenders now calculate interest on a daily basis. As flexible deals enable borrowers to reduce the lifetime of their loan by paying it off early, thousands of pounds can be saved.

According to Abbey National, a borrower who takes out a mortgage over 25 years and overpays the suggested repayments by £30 a month can reduce the mortgage term by three years and save £11,000.

"Once most people have got a mortgage they want to reduce their debt as soon as possible," says Andrew Paddock, head of mortgage and development at the Stroud & Swindon Building Society. "With a flexible mortgage, borrowers can not only make overpayments without being charged but can also use it to suit their own lifestyle; they can underpay, take payment breaks or draw back money they have already paid off."

Research from flexible mortgage specialist First Active reveals that flexible mortgages accounted for 11 per cent of gross lending last year. It predicts this will increase to 50 per cent by 2004. Some lenders, including the Woolwich and Stroud & Swindon, are discovering that flexible mortgages account for more than 50 per cent of new lending.

Interpretations of what is flexible can vary. The most flex- ible options, from Virgin and First Active, are best described as current account mortgages that combine your current account with your home loan.

It is an Australian invention and is a new concept for UK home owners. Your salary is paid directly into your account, with any monthly outgoings debited as normal. Whatever you don't spend will reduce what you owe on your mortgage.

"Any money you don't spend is overpay and will reduce your debt," says Adrian Webb, head of communications at Virgin One. "However, borrowers can draw back money at any time. The consolidation of a current account and mortgage account benefits borrowers as they are getting returns higher than a cash ISA (individual savings account), and it's tax-free."

Since launching in May 1998, the Virgin One account has attracted over 25,000 customers, but it's not for everyone. Psychologically, it is a big step to lump your mortgage, savings and current account together. Many lenders have discovered that not every customer wants to do that.

One needs self-discipline not to be tempted to splash out and spend what you don't have. You may think: "If I'm 'overdrawn' by £72,000 with a loan of £80,000, what does another couple of grand matter?"

"For someone who is financially aware and who monitors their expenses well, this type of product can be excellent," says Ian Darby, managing director of mortgage broker, John Charcol. "But for the majority, bank account mortgages are a step too far."

First Active offers a similar type of mortgage to Virgin, although borrowers don't have to combine their current account and mortgage loan. A safety net protects those who don't stick to the plan and underpay too often or draw back more than they can afford.

First Active has a minimum monthly repayment; borrowers can only underpay or take payment breaks if at some point they have overpaid.

"When we launched this product in 1995, British homeowners didn't know they wanted it," says Ian Giles, director of marketing at First Active. "However, its popularity shows customers are realising that flexible mortgages enable the borrower to tailor them to their individual lifestyle."

Flexible deals without a combined current account are available from a growing number of lenders too. Some, such as Egg, allow you to overpay but don't let you underpay without arrangement. Standard Life Bank limits the number of payment breaks to two a year while Abbey National allows you to take as many payment holidays as you want within your loan limit.

* Contacts: Abbey National, 0800 100800; Egg, First Active, 0800 550551; John Charcol, 0800 718191; Standard Life Bank, 0845-845 8451; Stroud & Swindon Building Society, 0800 616112; Virgin, 0845-600 0001; Woolwich, 0845-606 6566.