With so many different types of mortgages available, it’s not always easy to know which is which. So, here’s a quick, plain-talking guide so you can work out which type of mortgage might be best for you.
If you want to skip ahead to a particular section, these are the different types of mortgages we’ll talk about:
- How will you repay your mortgage?
- Repayment mortgages
- Interest-only mortgages
- Part-and-part mortgages
- Different types of mortgages – fixed and variable
- Fixed rate
- Variable rate
- Tracker rate
- Discounted variable rate
- Standard variable rate
- We’re here to help (so don’t panic!)
How will you repay your mortgage?
The first thing you need to consider is how you’ll repay your mortgage. There are three different types here, although, for most of us, a repayment mortgage is usually the only practical choice.
With a repayment mortgage, each month you pay back part of the money you’ve borrowed as well as paying the interest. This means that over the length, or term, of the mortgage, you’ll have repaid everything you borrowed, and all the interest owed. You’ll then own your home outright. Repayment mortgages are also referred to as capital and interest mortgages. The capital is the amount of money you owe in your mortgage.
As you might guess from the name, an interest-only mortgage means you only repay the interest that you owe each month. Yes, this means that your monthly payments are lower than with a repayment mortgage. However, your payments don’t include paying off any of the money you’ve borrowed. By the end of the mortgage term, you’ll have paid off all the interest owed, but you’ll still owe the original amount of your mortgage.
At this point, you will be required to pay back the full mortgage amount, in one payment. A lender will typically only offer an interest-only mortgage deal if you can prove that you have an acceptable savings plan in place, so that you will be able to make this lump sum payment.
‘Part and part’ mortgages
A ‘part and part’ mortgage is just as it sounds. The total mortgage sum is split into one part repayment and one part interest-only.
Let’s imagine you borrow £150,000, with £100,000 on a repayment basis and £50,000 on an interest-only basis. Your monthly payments would pay off the interest accruing on the whole £150,000 borrowed, but only pay off the £100,000 repayment element. At the end of the mortgage term, you would need to pay the remaining £50,000 back in one lump sum.
As with interest-only mortgages, lenders typically only offer this option if you can prove you have a plan in place to be able to make this final payment.
Different types of mortgages – fixed and variable products
Now that you have an idea of repayment options, let’s look at the different types of mortgage products available. These fall into two categories – fixed rate and variable rate. The ‘rate’ here is the interest rate on your mortgage.
You won’t be surprised to know that a fixed rate mortgage is when the interest rate is fixed, or held, at the same rate for an agreed period of time, from the start of your mortgage. This is often for two or for five years but can be anything from one to ten or even 15 years. So, a ‘two year fixed rate’ mortgage would mean the interest rate won’t change until after the initial two years are up.
When the fixed rate period ends, your mortgage will move on to your lender’s standard variable rate (SVR). At this point you can consider arranging a new fixed rate period with your current lender or see if you can find a better deal with another lender.
Fixed rate mortgage pros
- Peace of mind – you know that your monthly payments won’t change for the duration of your fixed period.
- You can budget more easily, knowing exactly what your monthly payments will be.
- Even if interest rates rise during this time, the interest rate on your mortgage won’t.
Fixed rate mortgage cons
- If interest rates fall, you won’t benefit as your rate will remain the same.
- Interest rates on fixed rate mortgages can be higher than for tracker products.
- If you want to change your mortgage before the end of the fixed period, then it’s likely that you’ll have to pay an early repayment charge.
There are several types of variable rate mortgages, but the one thing they all have in common? You guessed it – the interest rate can vary during the term, or length, of the mortgage.
We’ll take a look at each in turn.
With tracker mortgages, it’s all in the name! A tracker mortgage rate tracks, or follows, a particular interest rate – most often the Bank of England base rate. The lender will then add a fixed percentage to the base rate. So, for example, if the base rate is 1% and your lender adds 2%, your interest rate will be 3%. If the base rate then increases to 1.2%, your rate would increase to 3.2%.
Some lenders will set a ‘collar rate’ on a tracker rate mortgage, which is a minimum rate that your interest rate cannot go under. We haven’t come across many lenders who set a limit on how high the rate can go though but this is called a ‘cap rate’.
Tracker rate mortgages are usually for two to five years. At the end of the tracker rate period, your mortgage will move on to your lender’s Standard Variable Rate (SVR) unless you arrange a new mortgage with your current lender or a new lender.
Tracker rate mortgage pros
- If the base rate decreases, then your interest rate will also decrease. You would then usually see a decrease in your monthly repayments.
Tracker rate mortgage cons
- You won’t have the certainty of knowing how much your monthly repayments will be.
- You may not benefit from any decrease in the base rate if this would take you below a set collar rate.
Discounted Variable rate
A discounted variable rate means that you have a discount on a lender’s standard variable rate (SVR) for an agreed period, from the start of your mortgage.
Your discount will be a set percentage of the SVR. This percentage will remain the same for the agreed period – often for between two and five years. Your monthly payments won’t necessarily remain constant for this period though, as your lender is able to change their SVR as they choose, at any time.
Here’s an example – a lender might offer a 1.5% discount off their SVR, and this will be set a two-year period. The SVR is currently at 4%, meaning you pay interest at 2.5%. If the lender then increases their SVR to 5%, your 1.5% discount would mean you now pay interest at 3.5%.
It’s important to consider the SVR as well as the discount offered in a deal – a smaller discount off a lower SVR could work out cheaper than a larger discount off a higher SVR.
As with tracker mortgages, lenders may set a ‘collar rate’ on a discounted variable rate mortgage, which is a minimum rate that your interest rate cannot go under.
Discounted variable rate mortgage pros
- These deals can offer great rates, particularly if SVRs are generally low and the Bank of England base rate is low.
- If your lender’s SVR decreases, then your interest rate will also decrease. You would then usually see a decrease in your monthly repayments.
Discounted variable rate mortgage cons
- Lenders can change their SVR as and when they choose, making it hard to budget for your monthly repayments.
- Your lender doesn’t have to follow the Bank of England base rate, so may choose not to decrease their SVR even if the base rate decreases.
- You may not benefit from any decrease in your lender’s SVR if this would take you below a set collar rate.
Standard variable rate
Standard variable rate (SVR) mortgages aren’t offered as initial mortgage deals – instead, a lender will offer you their current SVR.
Every lender has their own standard variable rate. They can set this at any rate they choose and change it at any time. Usually, SVRs roughly track a few percentage points above the Bank of England’s base rate movement. If you find yourself on an SVR then it’s always worth comparing it with available deals.
Standard variable rate mortgage pros
- If the Bank of England base rate decreases, then your lender may reduce their SVR, meaning your interest rate would decrease. You would then usually see a decrease in your monthly repayments.
- There are usually no early repayment charges if you choose to make early repayment on your mortgage and pay it back in full.
Standard variable rate mortgage cons
- They can be expensive – rates are generally higher than the rates offered on deals on the market.
- The interest rate can be increased at any time, by any amount, making it difficult to budget for monthly payments.
- If the Bank of England base rate increases, then it’s almost certain that your lender will increase their SVR.
Are there even more different types of mortgages?
In short – yes! However, these are specialist mortgage products, available to those with unusual circumstances. This could be Expat mortgages for people working overseas, mortgages for members of the Armed Forces or perhaps mortgages for a second home.
If you find yourself in an unusual situation then please speak to us to find out about the options that may be available to you.
What else do I need to know?
Many lenders charge a product fee for a mortgage, and this cost can vary greatly from lender to lender. It’s important to factor any additional costs into the affordability of a mortgage, and when comparing the overall costs of different types of mortgages.
To balance out the additional costs, lenders may also offer incentives with a mortgage product. This could be in the form of a free property valuation, help with legal costs regarding your property purchase, or simply cashback. Again, it’s important to consider these alongside all the other factors.
Stisi Group is here to help!
We offer free, no obligation advice and consultations with our Trusted Mortgage Experts.. Handy if the world of mortgages feels a bit like a minefield!
The mortgage market is constantly changing. So, whether you’re buying your first home, looking to move home, or simply looking to make sure that you’re still on the right deal for you, we’re here to help.
We know our business inside and out and our unique Client Obsession programme means that you are our priority. We take the time to listen to you to make sure that we give you the advice you need. Don’t just take our word for it though – take a look at our reviews on VouchedFor and Google to see how we’ve been able to help other clients.
Want to get started? Just get in touch using the form below or give us a call – our advisers will be happy to answer any questions you may have, and to go through the whole mortgage process with you.
Call us on 0131 510 1240 or email us at [email protected].
Your home may be repossessed if you do not keep up repayments on your mortgage.
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