Read our blog post for our advice on different types of mortgages and find out which mortgage is right for you.
Our guide to the different types of mortgage
There’s been a lot of talk about mortgages in recent months – with interest rates being cut by the Bank of England to 0.25%, the return of 100% mortgages and concerns about what impact, if any, Brexit will have on the market.
What we also know about mortgages, though, is that they can cause a fair bit of confusion.
Prospective borrowers are met with any number of products, types and choices, and it can be hard to make sense of them all.
Whether you’re a first-time buyer, a second stepper, a downsizer, a last-time purchaser or a landlord/investor looking to grow your portfolio, you will want to know what mortgages are on offer.
Increasingly popular among buyers and sellers, a fixed rate mortgage pretty much does what it says on the tin. It means that your mortgage has an interest rate that is fixed for an initial term – this might be two, five or even ten years – ensuring that your monthly repayments will stay the same over this period, which is good for budgeting purposes and keeping your finances in check.
It also gives you certainty when it comes to other major financial outlays – you know what your mortgage payments will be each month, so you can budget around this (and other household costs) accordingly.
If you’re looking for peace of mind and consistency, a fixed-rate mortgage is the way forward.
Usually, at the end of the fixed-term period, the mortgage will transfer to the lender’s variable rate – but borrowers are advised at this point to shop around for the best possible deal.
The main advantage of a fixed rate is that you don’t need to worry about fluctuations in interest rates. You can be secure in the knowledge that you’ll be paying the same each month, regardless of anything else. First-time buyers, in particular, might appreciate the stability of a fixed-rate mortgage, as will those on tight budgets.
On the downside, though, you are likely to face a high arrangement fee for a fixed-rate mortgage.
While, of course, you could miss out on a more competitive interest rate if your lender’s standard variable rate (SVR) drops below the fixed rate.
A fixed rate mortgage could also leave you locked in and facing a penalty – commonly known as an early repayment charge – if you opt out of the deal before your term is up.
A tracker mortgage, by contrast, is one type of variable rate mortgage. It tracks the Bank of England base rate, which means your mortgage repayments will change when the base rates goes up or down.
Good news if the interest rate remains low or goes down – as it did very recently – but you run the risk of paying more if interest rates rise.
In recent years it’s been a gamble worth taking, with interest rates kept at record lows to stimulate the economy.
Typically, tracker mortgages follow the Bank of England base rate at a set margin above or below it. So, for example, your tracker mortgage might be Base Rate plus 1% - as things stand, that would mean you would be paying a rate of 1.25%. Tracker mortgages that are longer-term have a larger margin – i.e. base rate plus 3.5%.
Tracker rates will be either for an introductory period (generally one to five years) or a lifetime deal, which means that you will remain on the tracker rate for the duration of your mortgage.
When rates are low on your tracker mortgage, you will be able to overpay on your loan – which means that the length of your mortgage will reduce or your monthly payments will be lower.
However, if you want the security of knowing how much you’ll be paying each month, a tracker mortgage is not for you. Equally, an early repayment fee will be levied if you want to leave your tracker deal before the end of the agreed term.
Another type of variable rate mortgage is a discount one. This is when you pay the lender’s standard variable rate (which very rarely changes), but with a fixed amount discounted. So let’s say your lender’s SVR was 3% and your mortgage had a 1.5% discount, you would pay a rate of 1.5%.
Some variable rates have what is known as a ‘collar’ (a rate below which they cannot drop) or are capped at a rate they are unable to go above.
Standard variable rate
This is the mortgage you will usually be automatically transferred to when your fixed, tracker or discount mortgage comes to an end.
The standard variable rate is the rate set by your lender, and isn’t tied to the Bank of England base rate (it is however, influenced by its activity). A lender can lower or hike up its SVR at any time, something you will have no control over. The average SVR rate, as of August 2016, was 5.07%.
If the Bank of England base rate is low – as it currently is – SVRs can be beneficial. But the SVR, like all variable rate mortgages, provides no rate security, making it a possibly unwise choice for those on a strict budget.
The above are all repayment mortgages – where you repay, month by month, the money you have borrowed for your mortgage. You can, however, also take out an interest-only mortgage, where you only pay interest to your lender every month. In other words, you don’t pay off any of the money you’ve borrowed until the mortgage term ends (typically 25 years).
Of course, you will need to have other ways of paying back what you owe, whether that be through stocks and shares, pension money or other investments.
This is a risky strategy, though, as you may not have the funds to pay off your mortgage when the time arises. This could lead to your home being repossessed.
Increasingly, lenders are offering mortgages that appeal to this demographic. Whether it’s Help to Buy ISAs, shared ownership, Right to Buy or 5% deposit mortgages, lenders are recognising the need to cater to this ever-growing marketplace.