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If you’re looking to buy a property, then you will most likely need a mortgage. A mortgage is essentially a loan, designed to cover a large portion of the cost of a property up front. You will be required to put down a deposit, and you will need to make monthly repayments, usually over several decades, before you own the property deeds outright.
But when it comes to mortgages there’s more than one way to skin a cat. There are a lot of different types of mortgage on the market for buyers to choose from, and it can sometimes be difficult to figure out which one would be right for you without a little help. So today we’re going right back to basics, and looking at the 4 most common types of mortgages, the pros and cons of each one, and how to figure out which one would be suitable for you.
All The Mortgage Types
Now, before I get into this in too much detail, it’s worth highlighting that there are many more than 4 types of mortgages available out there. In fact, broadly speaking, there are typically about 13. They are:
- Repayment
- Interest-only
- Fixed rate
- Variable
- Tracker
- Capped
- First-time buyer
- High percentile
- Discount
- Offset
- Flexible
- Cashback
- Buy-to-let
It’s also worth knowing that each type will have very specific, niche mortgage options within them. For example, there are specialist mortgages for people with bad credit, for the self-employed, or for people who need a guarantor. And while many of those options are available all the time, the state of the economy does impact which types of mortgages are being offered by lenders. For example, in the current climate it’s quite rare to find a high percentile mortgage – but they are available if you know where to look. Which is why it’s always worth talking to a mortgage adviser. They will be able to assess your situation and give you a shortlist of mortgage options that suit you.
Repayment vs Interest Only
At the top line you have two choices, and your decision will impact the type of repayments you will make. Each of the 4 options I talk about in a second will have both repayment and interest only options, so it’s worth knowing what they mean first. With an interest only mortgage, your monthly repayments will only pay off the interest on your mortgage balance, leaving the actual amount you owe unchanged. You then need to pay off the entire loan at the end of the mortgage term. This can understandably be a bit scary, but interest-only mortgages are a good option for those who need a bit of flexibility in their repayments.
Generally speaking, the more common option is a repayment mortgage. With this model, you’ll pay off a bit of the loan as well as some interest as part of each monthly payment, so your balance and your interest gradually goes down over the term, and you should have paid it all off by the end of the mortgage term. You can also have a combination of both interest only and repayment mortgage, though this is quite rare.
Now that’s out of the way, let’s look at the 4 most common types of mortgages on offer., and why interest is the single most important factor in most of them.
Fixed Rate
With a fixed rate mortgage, the rate of interest you pay on your balance remains the same throughout the entire deal period, regardless of any changes to the interest rate elsewhere in the market. Fixed rate mortgages are usually offered for either two or five year periods, and when that ends you will be moved onto your lender’s standard variable rate (SVR) for interest (see below). This option could be suitable for people who aren’t sure if their income is going to change in the next few years, or who prefer to know exactly how much they will need to pay each month. This type of mortgage is the most popular out there, and it’s easy to see why. The main downside to this mortgage type is that if the market interest rate goes down, you end up paying more interest than you could have. So it’s really a trade-off between predictability and market stability.
Variable
Standards variable rate or (SVR) mortgages will vary from lender to lender. Each lender has their own SVR, and they can set it at whatever level they want, regardless of what the Bank of England base rate is. They can also change this rate at any time they like, so your payments could go up and down with their chosen SVR. To give you an idea, in January 2021 the average SVR was 4.41%* – which was higher than both the Bank of England base rate and most other mortgages on the market. This is why many people who are on an SVR, or are being moved from a fixed rate onto an SVR, would be wise to shop around and find a slightly better deal. In some circumstances these types of mortgages can be beneficial, especially if you find a lender with a favourable rate. But many people end up on this mortgage type by default, not realising they can remortgage to another deal if they wished.
*Source: Moneyfacts Treasury Reports
Tracker
With a tracker mortgage, once again your interest payments can and will change throughout the term. This is because your interest ‘tracks’ the Bank of England base rate (currently 0.75%, as of 12th April 2022), and charges in line with it, plus an extra % of the lenders choosing. For example, your mortgage might state that your interest payments will be the base rate plus 3% – so right now that would be 3.1% interest on your mortgage. In today’s mortgage market you’d likely take out a tracker mortgage as part of an introductory offer, with a fixed period (usually 2 or 5 years) before being moved onto a SVR mortgage. However, some lenders offer ‘lifetime tracker’ mortgages, meaning your mortgage rate will track with the base rate for its entire term. This means your mortgage payments could go down if the base rate goes down, but they could also go up, so you never have 100% certainty.
Discount
With a discount mortgage, you will pay the lenders SVR, but with a fixed amount discounted. So for example, if your lenders SVR was 4% and your mortgage came with a discount of 1.5%, then your interest rate would be 2,5%. But again, lenders can change their SVR at any time, so the repayments are not 100% consistent or predictable. Discount deals vary between lenders, and they can be ‘stepped’ – which means you can take out a three year deal and pay one rate for the first year, but a higher rate for the remaining 2. This can be useful if you’re choosing a lender with a low SVR, as your interest rate could end up quite cheap. Just be careful – some lenders SVR will have a ‘collar’ – a rate they cannot drop below, or a cap they can’t go above. So make sure you check for these features before you sign up so you know what you’re getting yourself in for.
When you’re looking to buy a home, I always recommend you speak with a mortgage adviser to find out what would be the most appropriate fit for your circumstances, and that you understand what each type of mortgage would mean for you. That way you’re going into it with your eyes open, and there won’t be any nasty surprises down the line.
If you would like to know more about mortgages, or have a chat about what kind of mortgage would work for you, then just get in touch with me today to book your consultation.
GP Norgate Financial Solutions are a trading style of Easy Street Financial Services Limited who are responsible for the advice.