How to Choose the Best Mortgage

Taking out a mortgage is one of the biggest financial decisions you can make, and choosing the right option is crucial. We covered the four main types of mortgages to help home buyers make an informed decision on which option is best for them. Read on to learn more about interest only, fixed rate, variable rate and repayment mortgages.

Interest Only Mortgage

An interest only mortgage is a loan where the borrower only pays the cost of the interest. This type of mortgage only lasts for a fixed period of time, usually between 5 and 7 years – after which the borrower will begin to pay off the full loan.

The advantage of this type of mortgage is that monthly payments are kept low at first, meaning the borrower’s money can be invested elsewhere over this time period. However, buyers must be confident that they will be able to afford the repayments once the interest only period has ended.

Fixed Rate Mortgage

When taking out a fixed-rate mortgage, the borrower and lender agree that there will be a fixed interest rate for a certain time period at the beginning of the loan – this can be between one and ten years. The benefit of this is that the borrower will know exactly how much they will be paying per month, regardless of what happens with interest rates outside of their mortgage.

A downside to this is that if interest rates drop, the buyer will end up paying more than they would if they weren’t on a fixed rate mortgage. It also means that there are high fines if they wanted to get out of the mortgage early.

Variable Rate Mortgage

When you take out a variable rate mortgage, your mortgage rate will go up and down depending on variables such as the UK economy. Interest rates are usually cut when the economy is suffering and increased when the economy is strong. Variable rate mortgages have three categories; tracker mortgages, standard variable rates and discounts.

Tracker Mortgages

In this type of variable rate mortgage, the interest rate moves in line with one particular economic indicator. Usually these payments work on a Base Rate +% basis. If the base rate that your mortgage is tracking increases, your payments will also increase. If the base rate drops, so will your payments.

Standard Variable Rate Mortgages

A standard variable rate mortgage has a variable interest rate that vaguely follows the Bank of England’s movements. Usually, borrowers who start on an interest-only or fixed-rate mortgage will end up on a standard variable rate mortgage once their initial fixed period has ended.

Discount Rate Mortgages

A discount rate mortgage offers a discount on the standard variable rate. Discounts usually only last for a few years, but there are exceptions to this. It is wise to ensure you have all the information you need about this type of mortgage, as terms can be unclear, and you may end up paying a lot more once the initial discount period has ended.

Repayment Mortgage

A repayment mortgage is when the borrower pays both the interest and the cost of the home together in instalments over a fixed period (commonly 25 years). This means that once the fixed period is over the borrower will have paid off both the house and the accrued interest.

Generally, your first few years of payments will be interest heavy, but the amount of capital you pay off will go up in bands throughout the fixed period.

Other Costs to Consider

Taking out a mortgage involves many other associated fees – from stamp duty to solicitors’ fees. If you are buying your first home, take a look at our guide to the costs involved.

Once you have an idea of the type of mortgage that would work well for you, speak to a mortgage broker about your options. Brokers will be able to give you any extra information you need and advise you on the best deals available. It may be that there is an option to combine mortgage types in a way that suits you. However, bear in mind that some lenders don’t offer their mortgages through brokers, so it is advised to do some of your own research as well.

For more help applying for your first mortgage read all about shopping around, consulting estate agents and finding low mortgage rates in our First Time Mortgage Application Guide.