Flex your mortgage muscle

More people are finding freedom in flexible mortgages. But with repayments calculated on a daily basis they don't suit everyone, especially those in arrears

The traditional mortgage sometimes looked like a straitjacket, binding you to 25 years of monthly payments until your home could finally be yours. All that has changed recently, with flexible mortgages. These give homeowners the freedom to increase or reduce their monthly payments, pay in lump sums or take payment holidays as it suits them. Overpay and you can knock years off your mortgage term and save thousands of pounds in interest.

The traditional mortgage sometimes looked like a straitjacket, binding you to 25 years of monthly payments until your home could finally be yours. All that has changed recently, with flexible mortgages. These give homeowners the freedom to increase or reduce their monthly payments, pay in lump sums or take payment holidays as it suits them. Overpay and you can knock years off your mortgage term and save thousands of pounds in interest.

But flexible mortgages are not the cheapest, and borrowers who don't make full use of the flexibility could do better with an old-style mortgage charging a more competitive interest rate. Flexible mortgages also offer no benefits to those on interest-only mortgages who are using an endowment or ISA to clear the capital on their loan.

A few years ago, flexible mortgages were offered by only a handful of lenders. Now more than 40 banks and building societies offer flexible mortgages in some shape or form.

Ian Giles, marketing director of specialist lender First Active, which has helped pioneer the concept of flexibility, says the most popular feature of a flexible mortgage is the ability to overpay: "Most people see their mortgage as a necessary evil and want to get shot of it quickly. It is an albatross around your neck, and the benefit of a flexible mortgage is that you can get rid of it sooner."

He says a flexible mortgage should allow you to over- or underpay, take a payment holiday, calculate interest on a daily basis and charge no redemption penalties. Many mortgages claiming to be flexible impose restrictions on these features. For example, Legal & General Bank, Standard Life Bank, Skipton Building Society and Egg do not allow underpayments on their flexible mortgages, while Abbey National imposes a minimum £500 on lump-sum withdrawals, and Egg imposes £250.

Abbey National, Standard Life Bank, Woolwich, Sainsbury's Bank, Market Harborough Building Society, Skipton Building Society, Mortgage Express, Bank of Scotland and others impose redemption penalties if you switch lender in the early years of your loan.

Your lender may offer a flexible mortgage, but this does not mean your particular deal is flexible. "A lot of people think they have flexible mortgages because major lenders such as Halifax and Abbey National offer some flexible products. But these may only be available to new customers or those who ask to change. Their older products will still be inflexible," Mr Giles says.

First Active research suggests that up to 15 per cent of new mortgages are fully flexible, while many more have flexible features. "We predict that by 2004 more than half of all mortgages will be truly flexible, although many more will claim they are," he says.

Current account mortgages, available through First Active and the Virgin One account, take flexibility a step further by merging your mortgage, current account, savings account and credit card spending into a single account. You are free to pay in or withdraw money at any time, although you cannot exceed the original loan granted. It does mean your bank account will always be in the red to the tune of your outstanding mortgage, which some may find unnerving, but there are benefits. By paying your salary, savings, bonuses and any spare money into the account and drawing on them when needed, you are reducing the size of your outstanding loan, which means you should pay it back sooner. Somebody borrowing £70,000 against a property worth £120,000 would pay 7.2 per cent with Virgin One. If they paid their annual £35,000 salary into the account each month, that would reduce the balance and clear the mortgage 12 months early, saving £6,291.

With all types of flexible mortgage, paying in extra money can greatly reduce your mortgage term and the amount you pay. If that Virgin customer paid an extra £150 each month, the borrowing would be cleared 10 years and eight months early, saving £38,708.

Siobhan Hotten, communications manager for mortgage brokers Charcol, says current account mortgages should only be considered by the financially disciplined. The ability to withdraw funds at any time means the profligate could take forever to clear their loan. Her favourite current account deal is a First Active 6.5 per cent rate, fixed until October 2002. She also admires a similar account offered by Halifax spin-off Intelligent Finance. "This is effectively a current account mortgage but allows you to keep separate accounts for each part of your money, keeping savings separate from your mortgage. This will be easier for most people to understand and should help them manage their money better."

She says the interest rate is also competitive, with a 1.5 per cent discount for the first six months on a 6.8 per cent standard variable rate, and no arrangement fee or redemption penalty. Also worth considering is the Yorkshire Building Society flexible mortgage, which currently charges 5.99 per cent fixed for one year, without any redemption penalties.

But she warns: "These days most people ask for a flexible mortgage, but when you pin them down all they really want is the ability to overpay. You can often achieve that just as easily with a standard fixed-rate product without redemption penalties, and pay less interest."

A key feature of flexible mortgages is that they calculate the interest you owe on a daily basis, rather than annually. This may seem like a minor point, but it is crucial to the flexible concept. Where interest is calculated daily, overpayments are credited immediately, cutting both your mortgage balance and the amount of interest charged. But if interest is calculated annually, you will have to wait up to 12 months before your overpayment is credited and interest payments reduced.

Intelligent Finance and its Flexible Tracker charge daily interest; Halifax still charges most customers on an annual basis. Its spokeswoman, Celia Rowland, says that daily interest calculations do not suit everyone.

"There is a downside, that if you go into arrears with your mortgage you will quickly suffer as you will start paying interest upon interest."