Once you begin looking for a mortgage, you’ll come to realise that there are many different types of mortgages out there on the market. It can quickly become confusing. However, there are essentially two main types of mortgages: fixed-rate and variable-rate mortgages.
In this guide, we are going to explain how each of these mortgage types work. We will also cover other common types of mortgage and some specialist mortgages that you may come across.
A fixed-rate mortgage is a mortgage product where the interest rate is fixed at a certain level. It is guaranteed to remain at that level for the initial agreed fixed period. They are one of the most popular options for mortgage borrowers, offering security and peace of mind to the borrower that their monthly repayments will remain unchanged throughout the initial fixed period and should therefore remain affordable.
It does mean, however, that borrowers won’t benefit should market rates happen to fall and borrowing becomes cheaper during that time. Additionally, borrowers are tied into the fixed-rate contract and cannot leave the deal early without incurring an early repayment charge. This can often amount to several thousand pounds.
Fixed-rate mortgages are generally available as either 1yr, 2yr, 3yr, 5yr, 10yr or sometimes 15yr deals. Most commonly though, they are either 2yr or 5yr deals. During the initial fixed term, the interest rate charged on your borrowing is fixed at the agreed rate. Therefore, your monthly repayments will also be fixed.
When this initial period comes to an end, your fixed-rate deal will expire. You’ll still have the same mortgage, but your interest rate will no longer be fixed. Instead, you will either be given the option to move to a new alternative deal, or you will be transferred to the lender’s standard variable rate (SVR).
With a variable rate mortgage, the interest rate is floating. This means that it can change at any time in line with market forces. The major, but not the only cause of rates rising or falling, is in response to changes in the UK economy and movements in the Bank of England base rate.
Possible changes in interest rates is something you must be prepared for when you set your original budget. It’s a good idea to either have enough spare capacity within your finances to absorb any increase in monthly cost or have sufficient savings set aside to supplement your income if needed.
If interest rates do go up, then so too will the cost of your monthly repayments. If interest rates were to fall, then you will benefit from the reduced monthly repayments required.
Variable-rate deals fall into three categories:
- SVRs – this is the standard interest rate your mortgage lender charges homebuyers and your borrowing will be charged at this rate for as long as you have your mortgage. There are normally no early repayment charges associated with SVR deals, so they provide flexibility allowing you the freedom to move between different deals and lenders without penalty and also allow you to make overpayments if you wish. The caveat is that your interest rate can go up or down at any point during the term.
- Tracker mortgages – tracker mortgages move directly in line with another interest rate, typically the Bank of England’s base rate. If the base rate increases by 1%, so will the interest rate on your borrowing. Tracker mortgages usually have a short life of typically 2-5 years before you are moved onto your lender’s SVR. Like the fixed-rate facilities, you may have to pay an early repayment charge if you wish to repay the borrowing or switch to another facility before the deal ends.
- Discount mortgages – this type of mortgage offers a discount off the lender’s SVR. Again, it only applies for an initial fixed length of time. This is typically 2-3 years. For example, if your lender’s SVR was 4% and your mortgage came with a 1.5% discount, you’d only pay 2.5% interest on your borrowing for that initial fixed period. Discount mortgage rates start off cheaper, making monthly repayments lower. However, the rate is variable. Rates can go up or down at any time – although you will enjoy a discount to the standard rate during those important first few years.
- Capped rate mortgages – with capped rate mortgages, once again your interest rate moves up and down in line with your lender’s SVR. There is, however, a cap on the rate. This means that rates and therefore monthly repayments cannot rise above a certain level. Capped rates are normally only available for an introductory period, typically 2-5 years. Whilst this might sound attractive and offers some protection against rising interest rates, the cap does tend to be set quite high. You will still need to be prepared to afford some increase in repayments if interest rates rise to the level of the cap.
Offset mortgages work by linking your savings to your mortgage and offsetting one against the other. The amount of your savings is deducted from the amount owing on your mortgage and you pay interest on the difference. This will have the effect of reducing your interest charge and therefore your repayments based on the level of savings you have.
For example, if you have £15,000 in savings and a mortgage worth £180,000, you’ll only pay mortgage interest on the net balance of £165,000.
With an offset mortgage, you will not earn any interest on your savings. Given saving rates are generally a lot lower than borrowing rates, this is not a great sacrifice. You can still withdraw money from your savings account with an offset mortgage. However, it will no longer be available to offset against your mortgage borrowing. Therefore, your mortgage interest charge will go up and so will your monthly repayments.
Mortgages will either be interest-only repayment or a capital and interest repayment mortgage. Occasionally, you can take out a combination of the two. With an interest-only mortgage, you don’t actually pay off any of the mortgage capital. You simply pay the interest due each month on the outstanding borrowing.
Whilst your monthly payments will be quite a bit lower than if you took a capital and interest repayment mortgage, your monthly payments won’t contribute towards the repayment of the loan itself. The capital of the loan will need to be paid off in full at the end of the mortgage term. This can either be from the sale of the property or from another source such as investment proceeds.
Interest-only mortgages have become much less common and very few new facilities are now being offered.
Repayment mortgages are far more common than interest-only mortgages. They are designed to ensure that, in addition to paying the loan interest charge each month, the borrower also repays an element of the capital borrowed. This means the loan will be repaid in full by the end of the agreed term.
Repayment mortgages are also known as capital and interest repayment mortgages. This is because borrowers repay part of the capital and all of the interest accrued each month.
There are certain situations where you may require a specialist type of mortgage. These can include:
- Bad credit mortgages – bad credit mortgages are designed to help those with a poor credit history get onto the property ladder. With these types of mortgages, you will generally have to pay a slightly higher interest rate. Lenders who specialise in these mortgages will deem you to be a higher risk.
- Buy-to-let mortgages – a buy-to-let mortgage is designed specifically for those who buy a property as an investment, rather than somewhere for themselves to live. If it is your plan to rent out your property, then this is not usually allowed under most standard residential mortgages. You will need to obtain one of these specialist mortgages instead.
- Help to Buy mortgages – when you make use of the government’s Help to Buy Equity Loan scheme, the government lends you up to 20% of the cost of your new build home (up to 40% in London), so you’ll only need a 5% cash deposit and a 75% Help to Buy mortgage to make up the rest (55% in London). To qualify for the Help to Buy scheme, you must be a first-time buyer purchasing a new build property from a Help to Buy builder. There are also regional price caps in place.
- Shared ownership mortgages – shared ownership mortgages allow you to make use of the shared ownership scheme. You purchase a share of a property, usually with the help of a shared ownership mortgage. A Housing Association retains the remaining proportion of the property and charges you a monthly rent to occupy their share. Think of it as a cross between buying and renting a house. Over time, you can staircase up and buy more shares in the property, increasing your ownership and reducing your rent.
- Guarantor mortgages – with a guarantor mortgage, a parent or close family member/friend takes on some of the mortgage risk by acting as a guarantor to provide a safety net for your borrowing. To be a suitable guarantor, this individual will need to meet the eligibility criteria of the mortgage lender, have sufficient disposable income available to cover your monthly mortgage commitment, and/or have cash savings or equity in property available to offer as security in case of your default.
- High net worth mortgages – high net worth mortgages are designed specifically for those in need of a mortgage of a higher value. Most high street lenders in the UK offer mortgages of up to around £1 million. For higher value mortgages, you may need to turn to high net worth mortgage lenders and private banks.
At Mortgage Light, we have an expert team with a diverse range of specialties. We can help you find the right fixed-rate or variable-rate mortgage for you, right through to catering for those with bad credit and high net worth – and everything in between.
Contact us today by calling 01908 597655, or fill out our online enquiry form. You can also reach us via the live chat, which you should find in the bottom right-hand corner of your screen.