What are the different types of mortgages?

Do all the different types of mortgages out there make your head spin? Fret no more, as we explain the various mortgages available in the UK and provide some handy advice on which type best suits you.

Do all the different types of mortgages out there make your head spin? Fret no more, as we explain the various mortgages available in the UK and provide some handy advice on which type best suits you.

Your first big decision is on what terms you want to pay back the mortgage. There are two main options:

  1. Repayment mortgages

You pay off the capital and the interest each month, whittling away at the total debt until you reach the end of the term and you’re free and clear. The standard term for a mortgage is 25 years, although you can arrange for 10, 15 or even 30-year terms.

  1. Interest-only mortgages

You only pay the interest that the loan accrues each month but you don’t touch the capital. At the end of the interest-only mortgage term you still have to pay the entire capital amount. The monthly payments are cheaper than most repayment mortgages, but that capital amount looms over you.

Often, people take out a policy (like an endowment) for the duration of the mortgage to ensure that they have adequate funds to repay the capital. The downside is that you have to pay the monthly interest on the mortgage, as well as the monthly endowment payment. There is also no guarantee that the market will perform well enough to generate the sum required at the end of the term.

The next decision is what type of interest rate you want to pay. There are several different types that are either fixed, variable or a combination of the two.

  • Fixed-rate mortgages

The interest rate remains fixed for the mortgage term. If you like to deal in certainties, then this is the mortgage rate for you. The downside is that if national interest rates go down, you don’t benefit. On the flip side, if the national interest rates go up, your mortgage repayments will remain unchanged.

  1. Variable-rate mortgages

There are two types of variable-rate mortgages available in the UK:

  • Tracker mortgages

Tracker mortgages are based on the interest rate determined by the Bank of England (BoE). So your mortgage repayments will go up and down as and when the BoE changes its rates. Note that the interest rate is not the same as that of the BoE, instead it’s the base rate plus whatever rate is offered by your mortgage provider (whether that’s a bank or building society). Interest rates on tracker mortgages tend to be lower than fixed-rate mortgages, so they might appeal to first-time buyers.

  1. Standard Variable Rate (SVR)

The interest rate on standard variable rate mortgages is determined by the mortgage provider. Mortgage providers can change their SVR whenever they feel like it – they are not bound by the BoE’s base rate. That’s not to say that SVRs chop and change at the drop of a hat; they tend to follow the base rate. In fact, they can be quite steady; you just need to be aware of the risk involved.

  • Capped rates

Capped rates are a combination of fixed- and variable-rate mortgages. The interest rate is capped at a maximum amount, so no matter how high the base rate (or SVR) goes, your monthly repayments never exceed that amount. But you benefit if the rates fall, because so do your monthly repayments.

But wait … there’s more

Your decisions don’t end there. Let’s take a quick look at the other types of mortgages available.

  • Offset mortgages

These offset your savings against your mortgage, which effectively lowers the balance of the debt and decreases the interest you have to pay. The nice thing about offset mortgages is that you pay off your mortgage quite quickly – and, of course, you can shave thousands of pounds off the total amount of interest you repay.

Offset mortgages are available at fixed and variable rates, so that’s another element for you to consider.

  • Buy-to-let mortgages

If you want to buy a house with a view to letting it out, you will need a buy-to-let mortgage. The deposit is usually higher than a conventional residential mortgage (25% to 40%) and the amount is affected by the potential rental income. For example, the rent should be 125% to 130% of the annual mortgage interest payments.

You can choose between variable- and fixed-rate mortgages.

  • Self-build mortgages

If you intend building a new home you will need to apply for a self-build mortgage. According to Clare Francis, the primary difference between a conventional residential mortgage and a self-build mortgage is the way in which funds are given. For self-builds, the funds are given in stages, partly to keep builders on track and on schedule and largely to reduce the mortgage provider’s risk.

Rates tend to be quite high, which mirrors the risk; however, there are considerable stamp duty savings. The deposit required for a self-build mortgage is also quite high; between 25 and 50 per cent.

  • Discounted mortgages

Discounted mortgages are sometimes offered on SVR mortgage rates. The discount is usually only valid for a limited time period – the first few years of the loan – and then standard SVR rates apply.

  • Joint or shared-ownership mortgages

As one would think, joint mortgages allow two (or more) people to combine their funds to get a good mortgage. It’s quite popular with couples who have been together for a long time but who have no plans to get married, or for married couples who keep separate finances and who want to share equally in the house. It’s important to draw up a written agreement before applying for a joint mortgage to iron out the exact terms of ownership, especially regarding tenancy, future sales and estate planning.

  • Bad credit mortgages

It is possible to get a mortgage even with a bad credit history, although you may have to go to a specialist bad credit mortgage provider. The interest rates on bad credit mortgages are quite high – in accordance with the risk – and indemnity payments and special “default” insurance is often required.

Getting a mortgage can be tricky, not least because there are so many complicated financial decisions to make. If you need any advice on buying or selling a house, Tepilo can help you at every stage of the process.

Get Started with Sarah Beeny's Tepilo now.