The Different Types Of Mortgages Explained

One of the most important things to decide when buying a new home is the type of mortgage to take out. There are many different mortgage types and the best one for you will depend on your circumstances.

This guide outlines the different types of mortgage available so you can decide what is right for you.

Types Of Mortgages?

All mortgages have something in common; you borrow money to buy a property at a given interest rate which you pay back over a set period. The following types of mortgages are available:

• Fixed rate mortgages
• Variable-rate mortgages
  • Tracker mortgages
  • Discount mortgages
• Standard variable rate mortgages

Fixed Rate Mortgages

With fixed rate mortgages, you pay the same interest rate for the entire mortgage period, regardless of external factors such as the Bank of England’s interest rate. The fixed period is generally between two and five years, although it is possible to get a fixed term of up to 10 years or more. At the end of the fixed term, you will usually be moved onto the lender’s standard variable rate (SVR).

Whilst the interest on these loans is typically higher than some alternatives, holders know exactly what they will be paying each month. Fixed rate mortgages are a good option for those on a tighter budget who want the stability of a fixed monthly payment.

Variable-Rate Mortgages

There are two types of variable-rate mortgages, tracker and discount.

Tracker Mortgages

With a tracker mortgage, your interest rate ‘tracks’ the Bank of England base-rate, currently 0.75%. The interest rate charged is the base rate plus an agreed percentage. For instance, you might pay the base rate plus 3% (3.75%).

Most lenders offer term trackers, which may be for 2 or 3 years. After this period, you will be moved onto the lender’s standard variable rate (SVR). There are a small number of ‘lifetime’ trackers available where the interest rate will track the base rate for the mortgage’s entire life.

If the base rate goes down, your monthly repayments will drop, but you won’t know how much your repayments will be each month. This is a viable option for those who have surplus income and can afford the risk that their monthly payments could go up as well as down.

Discount Mortgages

With a discounted mortgage, you pay the lender’s standard variable rate (SVR) less an agreed percentage. For example, if the lender offers a 1.5% discount off and SVR of 5%, you would pay 3.5%. These deals apply for a certain length of time, typically two or three years, after which you will move onto the lender’s SVR. Some deals can be ‘stepped’, meaning that you will get a bigger discount for an introductory period and a smaller discount for the deal’s remaining period. It pays to shop around with these mortgages because SVR’s differ across lenders, so don’t assume that a bigger discount will mean a lower interest rate.

The rates start cheaply, which will mean lower mortgage payments. If the lender cuts their SVR, you’ll benefit. However, your lender is free to raise their SVR at any point, which means your monthly payments would go up.

Standard Variable Rate Mortgages

Each lender has its own standard variable rate (SVR) which it can set at whatever level it likes. Generally, customers can’t apply for an SVR mortgage directly with a lender. You usually move onto a standard variable rate mortgage once a fixed rate or variable rate period ends.

The average SVR is currently around 4.61%. Most mortgage products have much lower rates it is usually better to take out another fixed or variable rate deal instead of moving onto the SVR.

Pro’s and Con’s of each type of Mortgage

Repayment Options

When deciding on a mortgage, you also have payment choices to make.

Capital Repayment

With a capital repayment mortgage, your monthly payments include an element that repays the borrowed capital as well as the monthly interest payments. At the end of the mortgage period, your debt will be fully paid off.

Interest Only

With an interest-only mortgage, your monthly payment only covers the interest on the loan. The amount you owe doesn’t reduce over time. You will need to demonstrate to the lender that you will be able to pay this off at the end of the loan period. For example, a second property that you can sell or a separate investment.

Specialist Mortgages

95% Mortgages

95% mortgages are useful for those seeking to get onto the property ladder but are struggling to save a large deposit. There is a much more limited choice of these mortgages, and the interest rates tend to be higher.

In the Spring Budget 2021, the government announced a new 95% mortgage guarantee scheme. The scheme enables first time buyers to secure a mortgage with a 5% deposit, with the government underwriting 95% of the mortgage loan. The scheme is available from April 2021 on properties worth up to £600,000.

Buy-To-Let Mortgages

A buy-to-let mortgage is the same as a residential mortgage, except you are taking out a loan to buy a property you don’t intend to live in. Most buy-to-let products are interest-only, and you will generally need a minimum of a 25% deposit.

Offset Mortgages

Offset mortgages can be used to ‘offset’ your savings against your full mortgage value. The lender takes into account how much you have in savings, and you will only pay interest on the mortgage balance, minus how much you have in savings.

E.g. – if you have a £200,000 mortgage and £20,000 in savings, you will only have to pay interest on £180,000.

Mortgage Features to Look Out For

Flexible Mortgages

A flexible mortgage may allow you to adapt your payments to reflect your financial situation at the time. This could be in the form of allowing you to make overpayments, underpayments or take payment holidays.

A flexible mortgage that allows overpayments means that you can pay less interest over the mortgage period.

Cashback Mortgages

A cashback mortgage is where the borrower can receive a cash lump sum once the mortgage has been approved. This could be anything from a few hundred pounds to several thousands of pounds. This is an incentive to buyers who may want to use the cash towards other costs such as solicitors’ fees or moving costs. There will be conditions to be met in order to qualify for this type of mortgage and the interest rates and fees may be higher than other types of mortgage, therefore, it is important to compare all mortgage deals to ensure that you are getting the best mortgage for your circumstances.

What Next?

There is a vast choice of mortgage products available, so it is important to do your research. When comparing deals, it may be useful to use online mortgage calculators. Ensure you look at the fees and exit penalties, as these can vary hugely between lenders.

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