Understanding the different types of mortgage
Whether you’re buying your first home or you’re familiar with the purchase process, it always helps to have a refresher on the different types of mortgage available.
Over time, the popularity of certain types of mortgage fluctuate, while government legislation and interest rates can also have a big effect on what you choose to take out.
How do mortgages work?
A mortgage is a loan used specifically for buying a property. The amount of money you need to borrow from a mortgage lender is simply the price of your new home, minus your deposit.
Interest rates and fees are then added, with different rates available depending on the type of mortgage you choose.
Different types of mortgage
There are three main types of mortgage: fixed rate, variable rate, and tracker.
Fixed rate mortgages mean your interest rate is set for a fixed period of time so you know what your repayments will be no matter what happens to the Bank of England base rate or the market. Typically, the term for a fixed-rate mortgage is 2-5 years, but can last 10 years, and as a general rule, the longer the term you agree to, the higher the interest rate will be.
Variable rate mortgages are when the interest rate changes in line with market conditions, but not necessarily the bank’s base rate. Often, new borrowers receive a discount for a set initial period, commonly as 2 years, before the rate reverts back to the standard variable rate (SVR).
Tracker mortgages have interest rates which fluctuate with the bank’s base rate which is decided by the Bank of England’s Monetary Policy Committee. If, for instance, your variable base rate is plus 3%, your rate would be 3.5% when the base rate is at 0.5%.
Other mortgage types include:
- Discount mortgages, which change in line with a lender’s standard variable rate
- Capped rate mortgages
You may pay a penalty if you swap your mortgage or pay it off during the initial term. This is called an early repayment charge. However, you can take your mortgage with you when you move home, which is known as “porting”, but you should check the terms of your agreement before you consider.
Whatever mortgage you’re considering, it’s important to shop around and get honest, impartial advice.
Mortgages for first time buyers
As a first time buyer, you don’t have to apply for a specific type of mortgage, but there are a number of deals designed exclusively for people just getting onto the property ladder. London Help to Buy equity loan is one example.
London Help to Buy is a government-backed scheme designed to help you buy a home with a smaller deposit. If you’re renting, it can be difficult to save a significant amount each month, which in turn means that it takes a long time to save a big deposit. With London Help to Buy, you can have a deposit as low as 5% of the value of your new home.
Under the terms of the scheme only new build homes are eligible. In London, you’ll put forward a 5% deposit and the Government will give you an equity loan of up to 40% (interest free for 5 years), meaning you only require a mortgage for the remaining 55%. So, if you’re buying a new home for £450,000 in London, you’ll only need a deposit of £22,500.
Which mortgage to choose?
Before choosing a specific type of mortgage, it’s worth weighing up the pros and cons of each, and getting impartial, professional advice. Some questions to consider include:
- How much risk am I willing to take with interest rates?
- What monthly repayments can I realistically afford?
- Do I want to pay the entire loan off over the course of the mortgage?
- Do I need extra help as a first time buyer?
Take your time, shop around, and only settle for the mortgage that’s right for you.
This guide to mortgages was produced in collaboration with L&C Mortgages, the UK’s largest fee free mortgage broker and adviser.