Types of mortgages

So, you’re thinking about taking that big step and getting a mortgage. As a first time buyer, this process can be overwhelming as there are several kinds of mortgages to choose from. Here is some useful information on what types of mortgages are available, to give you an idea of which is right for you!

Fixed Rate Mortgage

With a fixed rate mortgage, the interest rate stays the same throughout the duration of the agreement. This is usually between one to five years, however, it is possible to acquire a ten-year fixed rate mortgage.

Advantages

• Reassurance and security that if interest rates increase, your payments will remain the same
• You know exactly how much you’ll be paying back every month, making it easier for you to budget!

Disadvantages

• You are tied in for a specific amount of time, therefore, if interest rates fall you won’t be able to make the most of them
• If you opt to get out of your mortgage before your term ends, you’ll be charged a nasty penalty! Known as an Early Repayment Charge (ERC)
• The rates for fixed mortgages are higher than those offered if you went for a variable mortgage

Variable Rate Mortgages

 With variable rate mortgages, the interest that you pay can change. The following types of mortgages fall under this category:

 Tracker Mortgage

The interest rate of a tracker mortgage is connected to the Bank of England base rate, therefore, if this changes, so will your mortgage amount. Like fix term mortgages, trackers are available with different time periods, but are usually between two or five years.

For example, the current base rate is 0.50%. If you chose a tracker mortgage with a rate that is 3.00% above the base rate you will pay an interest rate of 3.50%. If the Bank of England increased the base rate up to 1%, your mortgage rate would increase to 4.00%, therefore increasing your monthly repayment.

Advantages

• Tracker mortgage rates are usually lower than fixed rates
• They’re easy to understand and keep track of as they are directly linked to the base rate
• They will only change if the Bank of England alters the base rate
• They are often flexible and penalty free if you have a lifetime or term tracker

Disadvantages

• You do not have the same security with a tracker like you do with a fixed term mortgage
• You should be prepared that your monthly payments may increase
• The Bank of England rate has been 0.5% since March 2009 and predications are it needs to increase

Standard Variable Rate (SVR)

This is the typical (default) interest rate your mortgage lender will charge homebuyers, which will be charged after your initial mortgage deal finishes until the end of your mortgage, or until you take out a different agreement. Alterations in the interest rate will occur after an increase or decrease in the base rate of the Bank of England.

Advantages

• Flexibility and freedom! You can overpay or leave at any given time

Disadvantages

• Your interest rate can change at any time during your mortgage

Discount Mortgage

Unlike trackers, the interest rate is linked to the mortgage lender’s standard variable rate (SVR). This is significantly different as lenders can change their SVR even if the base rate stays the same.

Discount mortgages are available over different terms too, generally being one to five years. Like fixed rate and some tracker mortgages, you will be charged a penalty if you choose to get out of it before your term has ended.

 Advantages

• Rates tend to be lower than fixed rate
• If the rate falls, your monthly payments reduce too!

Disadvantages

• Discount mortgages aren’t as transparent as trackers as the rate is linked to the SVR, not the base rate
• Lenders can choose to change their rate at any time, meaning if it increases, your monthly payments will too

Offset Mortgage

Offset mortgages are slightly more complex. They work by linking your savings and your current account to your mortgage, so you only pay interest on the difference. You will still repay your mortgage on a monthly basis, but your savings will act as an overpayment, helping you clear your mortgage earlier!

 Advantages

• As you’re paying more than you necessarily need to, you’re taking years off your mortgage, saving you thousands in interest, and they offer a substantial tax benefit
• Offsets can be appealing for people in the higher/top tax brackets

Disadvantages

• Rates on offset mortgages are usually higher than those on standard mortgages, so if you don’t have savings, or have a small amount, a normal mortgage may be best

Capped Mortgages

With capped mortgages, your rate is in line with the lender’s SVR, so this means the rate can’t increase above a certain level.

Advantages

• With capped mortgages, you can guarantee that your rate will not rise above a certain level. Meaning you can prepare for the peak
• Your rate will increase if the SVR decreases

Disadvantages

• The rates for capped mortgages are generally higher than other variable and fixed term rates
• The cap can be set reasonably high
• Your lender can change their rate at any time

It’s a lot of information to take in, but I hope this has helped you understand the different types of mortgages available. Choosing the right mortgage suitable for you is so important and can ultimately save you time and lots of money!

Mortgages are the largest outgoing for most households so be fully informed before you decide what is the best type for you. So consider:

1. Working through scenarios to determine what type of mortgage is best for you e.g. if your job changed, want to make additional payment etc.
2. Taking time to determine your (and your partner’s) borrowing habits; how would you would feel if interest rates fall (if fixed) or interest rates rise (if on variable)
3. Take advice. It’s free, regulated and easy to obtain.

See our other blogs on what to expect as a first time buyer and my own personal experience with mortgages.

Last updated by BeeMyMinder at December 2, 2015.