Whether you’re a first-time buyer who has just started searching for a home loan, or you’re looking to remortgage your existing property, you’ve probably encountered several different types of mortgages. Each one comes with its own terms and conditions, and its own pros and cons.
To help you get to grips with your choices, we’ve listed the eight most common home loans you’re likely to find. We also explain the different repayment options and share some questions you should ask when deciding which one is the right fit for you.
What type of mortgages are there?
Mortgage types broadly fall into two categories: fixed rate and variable rate.
The “rate” refers to the interest rate (interest is the fee charged for borrowing money, expressed as a percentage). Banks and mortgage lenders in the UK determine their interest rates based on the Bank of England base rate.
With a fixed-rate mortgage, your lender guarantees that the interest rate will stay the same (fixed) for a set amount of time. On the other hand, with a variable-rate mortgage, the interest rate can change (vary) from month to month.
Let’s explore these options in a little more detail.
1. Fixed-rate mortgage
A fixed-rate mortgage has an initial term (usually two, three, or five years), during which you repay the loan plus a fixed interest rate.
Once the term is over, the rate expires, and you have the choice of remortgaging to a new fixed deal (either with your current lender or a new one) or switching to your lender’s standard variable (SVR) rate. More on that in the next section.
Is a 5 year fixed mortgage a good idea?
A five-year fixed-rate deal can be a good idea, depending on your circumstances. The major benefit of a fixed-rate term is that you know exactly how much you need to pay each month. So, if you’re not planning on moving house or paying for a costly renovation, it could give you five years of predictable monthly payments.
However, the downside is that if mortgage rates fall during that time, you’ll be locked into a higher interest rate. And if you need to remortgage during the five-year term (for example, to release equity to fund emergency house repairs), you’ll have to pay an early repayment charge, which is usually a percentage of the outstanding balance of the mortgage.
Now, what are the different types of variable-rate mortgages?
2. Standard variable rate mortgages
Every mortgage lender has their own SVR, which they can set to whatever they want. Generally speaking, an SVR will be higher than a fixed-rate mortgage, though it can fall as well as rise. This means your monthly payments can change from one month to the next.
SVR mortgages aren’t directly linked to the Bank of England’s base rate, but they can be affected by it. For instance, if the bank rate goes up by 0.5%, the lender might choose to increase their SVR by the same margin.
Note: Lenders are free to raise their SVR anytime, even if the bank rate doesn’t go up.
3. Discount mortgages
As the name suggests, this mortgage gives you a discount on your lender’s SVR over a set period of time (usually two or three years). Again, the amount you pay each month can change if the lender decides to increase or decrease their SVR, but you’ll get a discount on the interest rate.
For example, if your lender’s SVR is 6% and you get a 2% discount, you’ll pay 4%.
4. Tracker mortgages
Unlike SVR and discount mortgages, a tracker mortgage is linked to the Bank of England’s base rate. It tracks the rise and fall of the bank rate (hence the name), and you’ll pay the bank rate plus an agreed margin.
For example, if your deal offers the base rate plus 1% and the base rate is 5%, you’d pay 6%. If the base rate goes up by 0.5%, your rate would increase by the same amount.
You can get tracker mortgages that are set for two or three years, or lifetime trackers that last for the entire mortgage term.
5. Offset mortgages
An offset mortgage lets you save on your mortgage payments by using your savings to reduce the interest you pay. To qualify, you need to have your mortgage and a savings account with the same bank or lender and link the two together.
You don’t actually use your savings to pay off your mortgage. Instead, you “offset” your mortgage against it. This means your lender subtracts the amount in your savings from the amount you owe on your mortgage, and you only pay interest on what’s left.
For example, if you have a £250,000 mortgage and £25,000 in savings, you’d pay interest only on £225,000 of your mortgage instead of the full amount.
The downside is that your savings won’t earn any interest if it’s used to offset your mortgage. So you need to consider if you could save more by lowering your mortgage interest rate than you would earn in a savings account.
Other types of mortgages to know
Setting interest rates to one side, there are also different mortgage types for various situations. You might be eligible for one of the mortgages listed below, depending on your circumstances.
6. Joint mortgages
When you buy a property with another person (a spouse, partner, friend, or family member), you’ll take out a joint mortgage. This could be any of the mortgage types we’ve listed above but with both parties named on the mortgage agreement and property deeds. Both people will be responsible for the repayments.
A joint mortgage could help increase the amount you can borrow from a lender. Generally speaking, lenders let you borrow around 4.5 times your annual income. If you earn £25,000 a year and buy alone, you might be able to borrow up to £112,500. If your partner also earns £25,000, you could potentially borrow up to £225,000.
7. Guarantor mortgages
A guarantor mortgage involves a parent or close family member taking on some of the responsibility for the mortgage by guaranteeing that they will make repayments if you can’t.
The main benefit of using a guarantor is that it can help you get onto the property ladder if you’re struggling to get a mortgage on your own.
However, there are risks involved. If the property has to be repossessed and sold, the guarantor will be liable for any outstanding mortgage debt. To pay this, they could lose a chunk of their savings or even their own home.
8. Buy-to-let mortgages
Finally, if you’re interested in buying a property to rent out as an investment, you’ll need a buy-to-let (BTL) mortgage to fund the purchase. The rules surrounding BTL mortgages differ from those of residential mortgages, and the lending criteria are usually stricter.
To qualify for a BTL mortgage, you’ll probably need to own your own home and put up a bigger deposit (usually a minimum of 25% of the property’s value). You also need to demonstrate that you can afford to make the repayments if you don’t have tenants.
Mortgage payment options: Repayment vs. interest-only
When choosing a mortgage, you also have a decision to make regarding the repayments.
The money you borrow from a mortgage lender is called “the capital” and you’ll be charged interest on the loan. You can either make payments to pay back a portion of the loan plus interest each month, or you can pay only the interest each month and repay the balance of the loan in full at the end of the term.
Here’s a little more on each option:
- What is a repayment mortgage? The most common type of mortgage in the UK, a repayment mortgage lets you steadily repay the money you’ve borrowed plus interest each month. At the end of the mortgage term, you’ll have paid off the entire loan (capital and interest).
- What is an interest-only mortgage? As the name suggests, your monthly payment only covers the interest charged on the capital you’ve borrowed. So, unlike a repayment mortgage, the total amount you owe doesn’t reduce over time. At the end of the mortgage term, you’ll have to pay off the loan in full.
To qualify for an interest-only mortgage, you must prove to the lender that you have a plan to pay the mortgage balance (such as savings, investments, or property that you can sell to raise funds). Interest-only mortgages are mostly commonly used for buy-to-let properties.
Key takeaway: What are the best types of mortgages?
Whether you opt for a fixed or variable rate, or a repayment or interest-only mortgage, will depend on your circumstances and whether you plan on living in or renting out your property.
To figure out which mortgage type is right for you, ask yourself:
- Do I expect my income to change during the mortgage term?
- Would I like to know exactly how much I’ll be paying each month?
- Could I afford it if the interest rates changed and my monthly repayments went up?
Whichever type of mortgage you choose, make sure you’re protected.
Mortgage insurance (sometimes called mortgage payment protection insurance or MPPI) is a type of policy that provides policyholders with mortgage payment support. It can help you make your monthly mortgage repayments if your usual income changes unexpectedly due to unemployment, redundancy, disability, hospitalisation, accident, or long-term sickness.
Be ready for the unexpected and protect your monthly payments with mortgage insurance from Howden. Find out more here.
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