How to choose the right mortgage
When you start looking round for a mortgage, you'll soon realise that there are loads to choose from. So many in fact that the choice can be overwhelming and you probably don't know where to start. You know you'll want to pick the best mortgage rate but you should understand that this doesn't necessarily mean going for the cheapest because other factors can affect your choice.
There's a lot to take into account before deciding which mortgage you want.
You'll find it helps if you have a broad understanding of how mortgages work and the various different kinds of mortgage available.
How do mortgages work?
All mortgages work in the same basic way: you borrow money to buy a property, pay interest on the loan and eventually pay it back.
Then they start getting complicated and you are looking at:
- different interest rates
- different ways to repay
- borrowing for different periods of time
- particular mortgages for special situations
- various charges to pay
What are the different types of mortgage?
There's a long list:
- repayment mortgages
- interest-only mortgages
- fixed rate mortgages
- variable rate mortgages
- tracker mortgages
- discounted rate mortgages
- capped rate mortgages
- cashback mortgages
- offset mortgages
- 95% and 100% mortgages
- flexible mortgages
- first time buyer mortgages
- buy to let mortgages
This is the basic way of repaying all mortgages, however specialised they are, apart from interest only loans which are different.
With repayment mortgages, each month you repay some of the interest you owe plus some of the capital you've borrowed. At the end of the period, often 25 years, you'll have paid back everything you owe and you'll own your home outright.
Of course you're likely to move within the 25 years. In this case, you might be able to take the mortgage with you (called 'porting' your mortgage) or you can repay the original loan and take out a new one.
It could be that, by the time you move, your house has gone up in value and anyway you will have repaid some of the capital. So next time you can put down a bigger deposit and possibly find a new mortgage at a better rate of interest.
Good for: buyers who want to be certain their house will be paid for at the end of the mortgage.
Interest only mortgages
With interest-only loans, you pay just the interest month by month and repay the capital at the end of the period with money you've saved elsewhere.
This is quite different from a repayment mortgage because at the end of the loan you'll have to find enough money to repay the whole debt. You can save up any way you want or use money from an inheritance but you must be confident of having the money to hand when the time comes to repay. If you don't, you might have to sell the house to pay off the mortgage.
You could be lucky and find that your home has increased so much in price that the extra value is enough to remortgage and pay off the debt.
There's still a risk that won't be able to repay the mortgage on time so, before granting an interest-only mortgage, lenders can insist you show them how you intend repaying the loan at the end.
The big advantage of interest only mortgages is that your monthly repayments are lower than with any other mortgage because you are paying only the interest due. If you find you're getting nervous about being able to repay the loan on an interest only basis, you may be able to switch to a repayment loan at a later date.
Good for: buyers who want the lowest monthly repayments and are confident they will have enough money to repay the debt at the end of the mortgage.
Fixed rate mortgages
Fixed rate mortgages are popular, particularly with first time buyers, because your mortgage rate is fixed for a set number of years - usually 2, 3 or 5 years but sometimes 10 years. You know exactly how much you'll be paying each month for that length of time, regardless of what happens to interest rates on other mortgages.
The downside is that you'll be stuck on a higher rate if other mortgage rates go down. You can get out of a fixed rate mortgage but there'll be an early repayment charge to pay for switching before the end of the period.
When the mortgage comes to an end, you'll be put on the lender's standard variable rate (SVR) which will probably have a higher interest rate than you've been paying. In that case you can apply for another fixed rate deal.
Good for: buyers who are budgeting carefully and want to know exactly how much they'll be paying over the next few years.
Variable rate mortgages
Every lender has a standard variable rate (SVR) mortgage. This is their basic mortgage. The interest rate goes up and down as mortgage rates generally change. They are partly influenced by the Bank of England base rate but other factors come into play as well. The interest rate you pay on an SVR mortgage can change even without base rate moving and similarly base rate might come down but your mortgage rate stays the same.
Good for: buyers who think mortgage rates are going down but better deals are probably available elsewhere.
Tracker mortgages move in line with (i.e. they track) a nominated interest rate which is usually the Bank of England base rate. The actual mortgage rate you pay will be a set interest rate above or below the base rate. When base rate goes up, your mortgage rate will go up by the same amount. And it'll come down when base rate comes down.
Some lenders set a minimum rate below which your interest rate will never drop but there's no limit to how high it can go.
With base rate at 0.5% and an add-on rate of 1.5%, your mortgage rate will be 2%.
Good for: buyers who can afford to pay more if rates go up but believe that rates will go down.
Discount rate mortgages
The discount is a reduction on the lender's standard variable rate (SVR). Mortgages with discounted rates are some of the cheapest around but, as they are linked to the SVR, the rate will go up and down when the SVR changes.
The deal, though, lasts only for a fixed period of time, typically 2 to 5 years.
Good for: buyers who want a low rate of interest but can afford to pay more if rates go up.
Capped rate mortgages
This is a variable rate mortgage but one with a ceiling (a cap) on how high your interest rate can rise.
You have the comfort of knowing that your repayments will never exceed a certain level while you can still benefit when rates go down.
As mortgage rates generally have been low in recent years and there are better deals around, lenders don't often offer capped rate mortgages at the moment.
Good for: buyers who believe mortgages rates are going to get a lot higher.
This is a marketing incentive sometimes offered by lenders. When you take out their mortgage, they give you money back, typically a percentage of the loan. This isn't necessarily as attractive as it first sounds. You should look carefully at the interest rate being charged and any additional fees as you'll likely find cheaper mortgages without cashback.
Good for: buyers who need a lump sum of money to help with moving house.
Offset mortgages are linked to a savings account and combine savings and mortgage together.
Each month, the lender looks at how much you owe on the mortgage and then deducts the amount you have in savings. You pay mortgage interest just on the difference between the two. 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.
This cuts the amount of interest you pay but the mortgage rate is likely to be more expensive than on other deals. You can still access your savings if you need to but the more you offset, the quicker you'll repay your mortgage.
When you use your savings to reduce your mortgage interest, you won't earn any interest on them but you won't pay tax either which is particularly helpful for higher rate taxpayers.
Good for: buyers who have a good amount of savings, especially higher-rate taxpayers.
These are for people who can afford only a 5% deposit. With such a small deposit you are at risk of falling into negative equity if house prices go down - they need fall only 6% and suddenly your house is worth less than your mortgage. Because of the risk, lenders will charge a comparatively high mortgage rate.
There's more information for people with 5% deposits in the government's Help to Buy scheme (http://www.helptobuy.gov.uk/) and our Help to Buy guide.
Good for: buyers who are struggling to save a deposit.
Flexible mortgages give you more leeway with making repayments. You can choose to pay in more than your regular amount when you can afford it (this option is also available on many other types of mortgage).
And, unlike other mortgages, if you have already overpaid you can pay less if you hit a difficult patch or even take a payment holiday and miss a few payments altogether. In return for this flexibility, the mortgage rate will be higher than on other deals.
Good for: buyers who suspect they will run into financial problems in future.
First time buyer mortgages
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 at least partly based on the amount of rent you expect to receive.
First time buyers are unlikely to be allowed a buy to let mortgage.
Before you decide which mortgage is right for you, there are more decisions you need to take. How long should you fix your mortgage for? Should you choose a fixed or variable rate mortgage?
Our mortgage advisers know how complicated the mortgage market is and they're happy to answer any questions you have. They'll help you find the mortgage that suits you best. There's no obligation and no charge for our service. It's fee free.