Understanding different types of mortgage
For most people, buying a new home is the biggest financial commitment they’re ever likely to make. That’s why it’s vital that you have a good understanding of the various types of mortgage on the market.
To help you choose the one that suits you best, here’s a quick guide to the different mortgage types – along with pros and cons for each.
With a fixed-rate mortgage, your repayments will be the same for a set period – typically two to five, or sometimes even ten years. This gives you the certainty of knowing what your repayments will be – regardless of what market interest rates are doing.
- Peace of mind that your monthly payments will stay the same
- Ideal for those on a tight budget looking for stability
- Fixed rate deals usually cost more than variable rate mortgages
- If interest rates drop, you won’t benefit from lower repayments
When a fixed-mortgage comes to an end, you will be switched onto your lenders standard variable rate (SVR) or you can remortgage and negotiate for another deal which is better you. If you want to switch before the deal ends, you’ll usually pay an early repayment charged better.
With a variable rate mortgage, the rate you pay could go or down up in line with the Bank of England base rate. On occasion, the lender may decide to change its standard variable rate (SVR) when the base rate doesn’t change.
There are several types of variable rate mortgages: tracker, standard variable rate and discount mortgages.
- If the base rate falls, your mortgage payment costs will fall
- Your rate is not affected by changes to your lender’s standard variable rate (see below)
- Usually cheaper than fixed mortgages so could be worth a gamble if you have spare cash
- If the base rate increases, your mortgage payments will go up
- You won’t know how much your repayments are going to be throughout the full deal period
- You might have to pay an early repayment charge if you want to switch before the deal ends
Standard variable rate mortgages
Standard variable rate mortgages
The standard variable interest rate, or SVR, is the lender’s normal interest rate. These are rarely available to new customers, but it’s good to know about SVRs as they’re the rate you’ll likely end up on after your deal or incentive period ends. While lenders’ SVRs are not directly linked to the Bank of England base rate, they do tend to follow it.
- You’re free to make overpayments or to switch to another deal at any time
- If the base rate drops, this rate will probably drop too
- The lender could increase their SVR at any time, meaning your mortgage payments will go up
- You could be paying more than you need to as trackers and discounts usually offer better deals
With a discount mortgage, you pay the lender’s standard variable rate with a fixed discount for a set period, typically two to three years. For example, if your lender’s SVR was 5% and your mortgage came with a 1.5% discount, you’d pay 3.5%. Keep in mind that SVRs differ across lenders, so it pays to shop around. Don’t assume that a big discount equals a low interest rate.
- While SVRs are low, your rate will be cheap and your repayments low
- Your rate will stay below the lenders SVR for the duration of your deal
- The lender is free to raise their SVR at any time, making it hard for you to budget
- If the Bank of England base rate rises, the lender will probably raise their SVR too
Portable mortgages mean you can transfer your existing mortgage to another mortgage product. However, you will have to re-apply with your current lender, even if your circumstances have changed. They do offer flexibility, but there is no guarantee your lender will allow you to port, such as if you are earning less than you were before.
- You will have built up more equity on your current home and should be able to access better mortgage rates
- You have to re-apply and there is no guarantee your lender will approve your application
- If you do port, you will be tied to the same lender and will have less choice of the rates on offer, meaning you could end up borrowing at a poorer rate of interest
Buy to let mortgages
Designed specifically for the rental market, buy to let mortgages are classed as business transactions where fees and rates are typically higher than normal mortgages. Minimum deposits for buy to let mortgages are usually 25% of a property’s value, while the maximum you can borrow is 85% LTV (loan to value).
- You will see a tangible return on investment as buy to let properties are advertised in terms of rental yield
- Interest rates are much higher than normal mortgages
- You have to be under a certain age, usually below 70 t0 75 years old, for your mortgage application to be accepted by a lender
When you want to change the mortgage deal on a property you already own, you can remortgage, either by moving to a deal with a different lender or a deal with your current lender, deciding whether you want to replace your existing mortgage or borrow money against your property.
- You will be able to borrow at a lower interest rate
- You will be able to switch to a more suitable product and use your property’s equity for additional cash
- You will be stretching your debts out over a longer period of time which can add to the overall cost
- There are other additional fees added to the cost of mortgaging
Other features to look out for
Making overpayments: If you’re able to pay more than your agreed monthly repayment, you’ll be able to clear your debt quicker – and save a substantial amount of interest in the process. Most mortgages allow you to make some overpayments, although they typically restrict the amount you can overpay to 10%. If you want to overpay more, look for deals with unlimited overpayments.
Taking payment holidays: With this feature, borrowers wishing to take a ‘holiday’ arrange to miss one or two payments, and their monthly payments are recalculated to spread the cost of those missed payments across the life of your loan. While this could be a useful feature in case of emergency, when you take a payment holiday, your repayments will go up.
Offset mortgages: With these mortgages, you keep your mortgage debt and savings with the same bank or building society. Your savings are then used to reduce – or ‘offset’ – the amount of mortgage interest you’re charged.
Cash back mortgages: Some deals offer cash back incentives. Although the costs of moving can make extra cash sound tempting, these deals often have high fees and interest. Be sure you look at the total cost before choosing a deal.
Extended offer periods: If you’re buying a home off-plan, shop around for a lender that provides extended mortgage offers for new-builds. Your new home might not be ready within the normal six-month offer period, so it’s good to have some extra time just in case.
To help you get the right rate for you, read how to find the best mortgage rate.
This guide to mortgages was produced in collaboration with L&C Mortgages, the UK’s largest fee free mortgage broker and adviser.