Choosing the right mortgage from the numerous options that cater to individual circumstances can be difficult. However, understanding mortgage-related terminology and the various types of deals can simplify selecting suitable options.
What's Included?
Mortgage types explained
All types of mortgages follow a similar process: You borrow money to purchase a property for a fixed number of years and pay interest on the amount you owe.
The amount you need to pay every month depends on various factors, which include the loan amount, the interest rate, the duration of your mortgage term, and whether you have selected a repayment or interest-only mortgage.
Repayment versus interest-only mortgages
Repayment or Capital and Interest mortgages are the most common type. These require you to pay back a portion of the borrowed money and the interest owed each month.
If you make all your payments by the end of your mortgage term, you will have fully paid off the original amount you borrowed along with interest, and your home will belong to you completely. You can select a shorter or longer mortgage term depending on how much you can pay monthly.
Certain types of mortgages operate on an interest-only basis where you only pay the interest amount each month, not any of the borrowed capital. The original amount borrowed is paid off only at the end of the mortgage term.
A mortgage with interest-only payments has lower monthly payments than a repayment mortgage. But it’s crucial to ensure sufficient savings to repay the entire loan amount by the end of the mortgage term.
To qualify for an interest-only deal, you must demonstrate to the lender that you have a savings strategy to cover the payments.
What are the different types of mortgage?
When it comes to mortgages, there are several options to choose from. However, understanding the different types can help make the choice simpler. Here are the main types of mortgage:
• Fixed-rate mortgages
• Variable rate mortgages, which include
• Tracker mortgages
• Discounted rate mortgages
• Capped-rate mortgages
Fixed-rate mortgages
A fixed rate mortgage means you will pay a predetermined interest rate for a specific period, usually lasting between two to ten years or potentially more. This means you can enjoy peace of mind, as your monthly payments will always stay the same, regardless of any fluctuations in the wider market’s interest rates.
If you opt for a fixed-rate deal, there is a potential risk that you will not be able to benefit from falling interest rates. If you plan to pay off your mortgage and switch to a new deal before your fixed rate term ends, you will likely incur Early Repayment Charges (ERCs).
It is common for you to switch to your lender’s Standard Variable Rate (SVR) after the fixed period ends, which can be more costly. If your fixed rate agreement ends soon, it is recommended that you start looking for other options now.
You can secure a new deal with many lenders several months ahead. This enables you to switch as soon as your current rate ends and avoid being shifted to a higher SVR.
Variable rate mortgages
A variable-rate mortgage implies that your monthly payments may change either positively or negatively in the future.
Most lenders will charge you the Standard Variable Rate (SVR) when your fixed, discounted or other mortgage deal ends. You can avoid this rate without paying Early Repayment Charges (ERCs).
Other types of variable-rate mortgages are also available. These include:
• Tracker mortgages
• Discounted rate mortgages
• Capped-rate mortgages
Tracker mortgages
A tracker mortgage follows a specific interest rate (often the Bank of England base rate) plus an additional percentage for a specific duration. If the base rate increases, your mortgage rate will increase by the same amount. Similarly, if the base rate decreases, your rate will go down. A few lenders set a collar rate as the lowest possible rate your interest rate can reach, but there is generally no limit to how high it can go. This type of mortgage is called a tracker mortgage because it follows the movement of a particular interest rate.
Discount rate mortgages
Discounted mortgages provide a reduced interest rate compared to the lender’s Standard Variable Rate (SVR) for a certain period, usually two to five years. Although discounted rate mortgages are among the most cost-effective choices, they are subjected to changes in the SVR, which can increase or decrease your interest rate.
Capped rate mortgages
Capped rates, like other variable rate mortgages, can fluctuate over time, but there is an upper limit, known as the cap, beyond which your interest rate cannot increase. This limit assures that your payments will never surpass a specific level while allowing you to reap the rewards when interest rates decrease.
This deal offers extra security but usually has slightly higher interest rates than the best discounted or tracker rates. Additionally, if you pay off your mortgage and remortgage to another deal, there will likely be an Early Repayment Charge (ERC).
Other kinds of mortgage
Offset mortgages
With an offset mortgage, you can use your savings to reduce the interest you pay on your mortgage. Instead of earning interest on your savings, the interest rate on your mortgage decreases. For instance, if your mortgage is £200,000 and you have savings of £10,000, the interest on your mortgage will be calculated on £190,000 for the month.
Usually, borrowers can either reduce their monthly mortgage payments due to a reduced interest rate or maintain their current payments to pay off the mortgage faster and decrease its overall term.
Savings are not subject to tax and can be withdrawn anytime because they don’t earn interest. Offset mortgages provide the option of fixed or variable rates depending on the preferred deal.
Buy to Let mortgages
Buy to Let mortgages are designed for individuals interested in purchasing a property to rent it out instead of using it as their residence.
When applying for a Buy to Let mortgage, the rental income you expect to receive will play a role in determining the amount you can borrow. However, lenders will also consider your circumstances and income. To ensure that you can manage increased mortgage rates in the future, lenders also apply a “stress test”. First time buyers may find it harder to obtain a Buy to Let mortgage.
Let to Buy mortgages
Let to Buy mortgages are for people who own a home and want to rent it out while purchasing a new home.
To clarify, if you plan to rent out your current home and purchase a new one, you’ll probably need to apply for two different mortgages. The total amount you can borrow will be based on your projected rental income, as well as your financial situation and income. Let to Buy mortgages can be difficult to comprehend, and there may be limited options, so it’s recommended that you seek advice to determine the best course of action for you.
What else do you need to know
The amount of deposit or equity in your property affects the range of mortgage deals available. Lenders consider those with larger deposits as lower risk, and therefore, they usually offer the best rates to them.
If you’re a first-time homebuyer struggling to save enough for a large deposit, don’t worry. Many lenders provide 95% mortgages, meaning they will lend you up to 95% of the property’s value that you intend to purchase.
To select the right mortgage, consider more than the advertised interest rate. Consider additional expenses like arrangement fees and any offered bonuses such as cashback and assistance with legal or valuation costs.
Our mortgage advisers can answer any questions about the complex mortgage market. Our service is free of charge, and we will assist you in finding the most suitable mortgage.
Frequently Asked Questions
1. What are the main types of mortgages in the UK?
The main types of mortgages in the UK are fixed-rate and variable mortgages. There are also a few specialist types for different circumstances¹.
2. What is a fixed-rate mortgage?
A fixed-rate mortgage is a type of mortgage where the interest rate stays the same for a set period of time, usually two or five years¹.
3. What is a variable mortgage?
A variable mortgage is a type of mortgage where the interest rate can change over time. There are several types of variable mortgages, including tracker mortgages, discounted rate mortgages, and capped rate mortgages².
4. What is a tracker mortgage?
A tracker mortgage is a type of variable mortgage where the interest rate tracks an external rate, such as the Bank of England base rate².
5. What is a discounted rate mortgage?
A discounted rate mortgage is a type of variable mortgage where the interest rate is set at a discount to the lender’s standard variable rate for a set period of time².
6. What is a capped rate mortgage?
A capped rate mortgage is a type of variable mortgage where the interest rate cannot rise above a certain level for a set period of time².
7. What is an offset mortgage?
An offset mortgage is a type of mortgage where your savings are used to offset your outstanding mortgage balance, reducing the amount of interest you pay³.
8. What is an interest-only mortgage?
An interest-only mortgage is a type of mortgage where you only pay the interest on your loan each month and not the capital¹.
9. What is an equity release mortgage?
An equity release mortgage allows you to release some of the equity in your home without having to sell it or move out¹.
10. What are specialist mortgages?
Specialist mortgages are designed for people with specific needs or circumstances, such as self-employed people or those with bad credit histories¹.
References:
- Mortgages in the UK: a guide for home buyers | Expatica. https://www.expatica.com/uk/housing/buying/your-guide-to-uk-mortgages-747470/.
- Mortgage types explained – Which? https://www.which.co.uk/money/mortgages-and-property/mortgages/types-of-mortgage/mortgage-types-explained-aIGHA3F2WqyQ.
- What different types of mortgages are available in the UK? https://themortgagegenie.co.uk/mortgage-types-explained
