The Simply Lending Guide to Mortgages
Whether you’re a first-time buyer or are planning to move home, when you’re looking for a mortgage one of the first things you realise is how many different types there are.
If you’ve decided to use a mortgage broker, they’ll do much of the hard work of finding you a suitable mortgage deal. However, it’s always useful to understand what the options they may present you with mean.
With that in mind we’ve put together this guide to answer the question “what are the different types of mortgages available?”
Differences in how you repay the mortgage loan
Mortgage repayment structures fall into 2 broad categories, either repayment or interest-only mortgages. We have described both structures below for information, although very few interest-only mortgages are available and in all probability any mortgage we arrange for you will be a repayment mortgage, unless it’s a buy-to-let mortgage.
Repayment Mortgage
This is by far the most common way of paying back a mortgage loan. With a repayment mortgage, each of your monthly payments repays some of the original mortgage loan amount (the capital) together with some of the interest on that loan.
With a repayment mortgage the idea is that end of the mortgage term you will have paid back everything that you owe the lender. When you first start paying off a repayment mortgage the bulk of your monthly payments will go toward paying off the interest. However, as time progresses you will be paying off more of the capital each month.
Interest-only Mortgage
With an interest-only mortgage, as the name suggests, your monthly payments only repay the interest on your mortgage loan. At the end of the mortgage term you will be expected to pay back the original loan amount in full.
A feature of this type of mortgage is that monthly repayments are lower than repayment mortgages.
Very few mortgages are interest only and the majority of them are used for buy–to–let mortgages. To have any chance of getting an interest only mortgage you’ll need access to a fairly hefty deposit – around 25% – as well as having a relatively high income.
Even if you fulfil these criteria, lenders will also want to see evidence that you have a convincing and viable plan to pay off your debt at the end of the mortgage term.
There are also a small number of ‘part and part’ mortgages which combine both methods of repayment.
Differences in how the interest rate is calculated
Mortgage interest rates are calculated at either a fixed or variable rate. The interest rates for variable rate mortgages are calculated differently depending on the type of mortgage deal you have.
Fixed-rate mortgages
What are they?
As the name suggests the interest rate for a fixed-rate mortgage is fixed for a set amount of time. The length of time that the rate is fixed for is generally around 2 to 5 years. Fixed-rate mortgages for longer terms tend to have higher interest rate.
After the length of your fixed deal has ended, the interest rate reverts to the lender’s standard variable rate (SVR). This rate is usually higher. You can of course choose to remortgage to switch to another deal.
What are the advantages?
The biggest advantage is that a fixed rate makes it easier to budget as you will know how much your monthly payments will be for the length of your deal. If interest rates rise during your fixed term deal your interest rate during that time won’t change.
What are the disadvantages?
While you won’t be penalised if interest rates rise, the downside is that you won’t benefit if interest rates fall.
It is possible to get out of your mortgage deal early if the rates do fall, but most deals make you liable for an early repayment charge. This will add considerably to your costs. In addition, fees for this type of mortgage can be higher.
Variable rate mortgages
Again, the clue is in the name. With a variable rate mortgage, the interest rate varies over time. Your interest rate is normally influenced by the Bank of England’s base interest, although the way in which it affects the rate depends on the type of variable rate mortgage you have.
Standard variable rate mortgages
What are they?
The standard variable rate is the usual interest rate that lenders charge. As mentioned above this is the rate that borrowers move onto once their mortgage deal comes to an end. It is unusual to take out a standard variable rate mortgage as your initial deal.
As standard variable rate mortgages are not tied to any other interest rate your lender may not increase the SVR in the event of, for example, an increase in the Bank of England’s base rate. However, they can change the rate at any time.
What are the advantages?
Unlike many other mortgages you are not ‘locked in’ to a deal term meaning that you won’t pay a penalty for repaying or changing your mortgage before the end of the loan term.
What are the disadvantages?
Standard variable rate mortgages are generally the most expensive mortgage rates available, and while lenders don’t have to put the rate up when the Bank of England’s rate goes up in practice they tend to.
Tracker mortgages
What are they?
Tracker mortgages are variable rate mortgages where the rate is determined by ‘tracking’ a nominated interest rate (usually the Bank of England’s base rate). Your rate is set at a point above or below the nominated interest rate and it then varies accordingly.
What are the advantages?
Unlike a fixed-rate mortgage if the rate that your mortgage is tracking falls, so does your interest rate. You may also find that any early repayment charges are lower than for other types of variable rate mortgages.
What are the disadvantages?
As may be expected, if the tracked interest rises then yours goes up too. Some tracker mortgages also set a rate below which your interest rate won’t fall – no matter how low the rate it is tracked to goes.
Discount rate mortgages
What are they?
These mortgage deals offer discount on the lender’s standard variable rate for a fixed period of time. For example, if the lender’s current SVR is 4.99% and you are offered a discount of 1% for 2 years you will start off with an interest rate of 3.99%. However, if the lender changes their SVR, then your rate will change too.
What are the advantages?
As with tracker mortgages, when the SVR is low then your interest rate will also be low. Discount mortgages offer come with relatively low arrangement fees which can make them cheaper initially.
What are the disadvantages?
As your interest rate is tied to your lender’s SVR you are really at their mercy. They may not reduce their rate when the Bank of England does, or they could raise it at any time.
Capped rate mortgages
What are they?
Capped rate mortgages can be SVR, tracker or discount variable rate mortgages. A capped mortgage sets a ceiling above which your interest rate cannot rise. There are relatively few capped rate mortgages available on the market
What are the advantages?
With a capped rate mortgage, you will still benefit when rates fall but you have an added level of security as you know that if rates rise above a certain point, i.e. the level of your ‘cap’, your mortgage won’t.
What are the disadvantages?
Your mortgage rate can still rise, just not above a certain point and caps tend to be quite high. Capped rate mortgages may be more expensive than equivalent mortgages without a capped rate.
Offset mortgages
What are they?
Offset mortgages can be eitherfixed rate or variable rate mortgages. The difference with an offset mortgage is that your savings are used to ‘offset’ some of the interest that you pay on your mortgage loan.
For example, if your mortgage balance is £150,000 but you have £25,000 of savings you will only be charged interest on a loan amount of £125,000. You can use this saving to either reduce the level of your monthly repayments or to shorten the term of your mortgage.
You can still add to your savings, and the more you add to them the more you will save. You won’t be paid any interest on your savings, and consequently you won’t be taxed on them.
What are the advantages?
When interest rates on savings are low you may find that you save more via an offset mortgage than you would have been paid in interest on your savings. The financial benefits of offset mortgages are particularly pronounced for people with large amounts of savings, as well as higher rate taxpayers.
You may also be able to use your savings to offset a mortgage for a family member. This can provide a useful option for parents wanting to help their children onto the housing ladder.
What are the disadvantages?
Interest levels on offset mortgages can be higher than other types of mortgage meaning that if you only have a small amount of savings any difference in rate after offsetting could be negligible.
You may also find that, again for people with fewer savings, a one-off overpayment -assuming your deal allows overpayment – will result in a greater saving.
So far we’ve looked at the choices you will need to make when considering how you repay your mortgage and how your mortgage interest will be calculated. But these are not the only considerations.
Mortgage deals often come with offers such as cashback and fee discounts, and some deals are more flexible that others; with the option for example of overpaying or taking payment holidays. These offers and features may be applied to any type of mortgage regardless of how it is repaid or how the mortgage interest is calculated.
While this guide will hopefully have explained some of the different types of mortgage available, it is this complexity that makes it advisable to speak to a professional mortgage broker when considering your options.
A mortgage broker will understand all the variables, and how they relate to your individual circumstances. Speaking to Simply Lending Solutions today will help you to clarify what your mortgage choices are.