Types of Mortgage
With so many different mortgage deals to choose from, finding the right one for your individual circumstances can feel a bit like hunting for a needle in a haystack.
However, once you’ve got to grips with all the jargon associated with mortgages, and the different kinds of mortgage deal that are available, narrowing down your choice of options becomes much easier.
If you’re looking for information on a specific mortgage type, you can navigate quickly using these links:
Mortgage types explained
All mortgage types work in the same basic way: you borrow money to buy a property over a set term, and pay interest on what you owe.
How much you pay back each month is determined not only by how much you’ve borrowed, and the rate of interest you’re paying, but also how long your mortgage term is, and whether you’ve opted for an interest-only or repayment mortgage.
Repayment versus interest-only mortgages
Most mortgages are arranged on a repayment basis, also known as a Capital and Interest mortgage. This means that every month you repay a portion of the capital you’ve borrowed, as well as a part of the interest you owe.
By the end of the mortgage term, assuming that you’ve made all of your payments, you will have repaid the original amount you borrowed, plus interest, and you will own your home outright. You can opt for a shorter or longer mortgage term depending on how much you can afford to pay each month.
Some mortgages however, are arranged on an interest-only basis. This means you repay the interest you owe each month, but not any of the capital you’ve borrowed. You only pay off the original amount you borrowed at the end of the mortgage term.
The advantage of an interest-only mortgage is that monthly payments will be much lower than with a repayment mortgage, but the downside is that you must be certain you’ll have saved up enough by the end of your mortgage term to repay the amount you borrowed.
To be eligible for an interest-only deal, you’ll need to be able to prove to the lender that you’ve got a savings plan in place to cover this.
What are the different types of mortgage?
The main types of mortgage are:
• Fixed rate mortgages
• Variable rate mortgages, which include
• Tracker mortgages
• Discounted rate mortgages
• Capped rate mortgages
Fixed rate mortgages
With a fixed rate mortgage, as the name suggests, you pay a fixed rate of interest for a set term, typically ranging from two to ten years, or sometimes even longer. This can provide valuable peace of mind, as your monthly mortgage payments will be the same every month, regardless of whether or not interest rates increase on the wider market.
The downside is that if interest rates fall, you will be locked into your fixed rate deal.
If you want to pay off your mortgage and switch to a new deal before your fixed rate comes to an end, there will usually be Early Repayment Charges (ERC’s) to pay.
After the fixed period finishes, you will normally move onto your lender’s Standard Variable Rate (SVR), which is likely to be more expensive. If your fixed rate deal is coming to an end in the next few months, it’s a good idea to start shopping around now.
Many lenders allow you to secure a new deal several months in advance, allowing you to switch across as soon as your current rate ends, and avoid moving to a higher SVR.
Variable rate mortgages
If you have a variable rate mortgage, this means that your monthly payments can go up or down over time.
Most lenders will have a Standard Variable Rate (SVR), which is the rate charged when any fixed, discounted or other type of mortgage deal comes to an end. There are usually no Early Repayment Charges (ERCs) if you want to switch away from your lender’s SVR.
There are several other types of variable rate mortgage available too. These are:
• Tracker mortgages
• Discounted rate mortgages
• Capped rate mortgages
Tracker mortgages, as the name suggests, track a nominated interest rate (usually the Bank of England base rate), plus a set percentage, for a certain period of time. When the base rate goes up, your mortgage rate will rise by the same amount, and if the base rate falls, your rate will go down. Some lenders set a minimum rate below which your interest rate will never drop (known as a collar rate)but there's usually no limit to how high it can go.
Discount rate mortgages
Discounted mortgages offer you a reduction from the lender's Standard Variable Rate (SVR) for a certain period of time, typically two to five years. Mortgages with discounted rates can be some of the cheapest deals but, as they are linked to the SVR, your rate will go up and down when the SVR changes.
Capped rate mortgages
Like other variable rate mortgages, capped rates can go up or down over time, but there is a limit above which your interest rate cannot rise, known as the cap. This can provide reassurance that your repayments will never exceed a certain level, but you can still benefit when rates go down.
The additional security of this type of deal means that interest rates tend to be slightly higher than the best discounted or tracker rates. There will also usually be an Early Repayment Charge (ERC) if you pay off the mortgage in full and remortgage to another deal.
Other kinds of mortgage
An offset mortgage enables you to offset your savings against your mortgage, so that instead of earning interest on your savings, you are charged less interest on your mortgage debt. For example, if you have a mortgage of £100,000 and savings of £5,000, your mortgage interest is calculated on £95,000 for that month.
Borrowers can usually choose to either reduce their monthly mortgage repayments as a result of the reduced interest charge, or keep their monthly payments as they are in order to reduce the overall term of the mortgage by paying it off at a faster rate.
As you don't earn interest on your savings, there is no tax to pay on them, and you can take your money out at any time. Offset mortgages can either have fixed or variable rates, depending on which kind of deal you want.
Buy to Let mortgages
Buy to Let mortgages are for people who want to buy a property and rent it out rather than live in it themselves.
The amount you can borrow is partly based on the amount of rent you expect to receive but lenders will take your income and personal circumstances into account too. They must also apply a ‘stress test’ so that they can see whether you’d be able to afford higher mortgage rates in future. First time buyers will find it more of a challenge to get a Buy to Let mortgage.
Let to Buy mortgages
Let to Buy mortgages are designed for homeowners who want to let out their current home to tenants and buy a new property to live in.
You’ll need two mortgages – one for the home that you’re going to let out, and one for your new property that you’re going to live in. The amount you’ll be able borrow is based both on how much rent you think you can get for your current home, along with your income and other financial circumstances. Let to Buy mortgages can be quite complicated, and the range of deals available may be quite limited, so it’s well worth seeking advice on the best options to suit your needs.
What else you need to know
The range of mortgage deals available to you will depend on how big a deposit you have to put down, or the level of equity you have in your property. Lenders usually offer their best rates to those with larger deposits, as they are considered lower risk.
Don’t despair if you’re a first time buyer finding it impossible to build a big deposit, however, as several lenders offer 95% mortgages, whereby they will lend you up to 95% of the value of the property you are buying.
When choosing a mortgage, don’t just look at the headline rate alone. It’s important to factor in any other costs, such as the arrangement fee, and to look at any incentives the mortgage might come with, such as cashback, or help with valuation or legal costs.
Our mortgage advisers know how complicated the mortgage market can be and they're happy to answer any questions you have. There's no charge for our service, and we'll help you find the mortgage that suits you best.