Types of Mortgages

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Analysing the different types of mortgages

When looking for a mortgage, there are lots to choose from, not just interest rates and fees. You borrow money against a property, pay interest on the loan, and repay it. You can repay the mortgage on a repayment basis, i.e., you pay some capital and the monthly interest accrued, and at the end of the term (25 years or 30 years), you will have paid back the whole amount, and you’ll own your home outright.

Alternatively, you can choose to repay the mortgage on an interest-only basis. Here, you pay the accrued monthly interest only for the whole term, and at the end of the term, you will still need to repay the original amount you borrowed.

There are two main types of mortgages:

Fixed-rate mortgage: Your mortgage is fixed for a set number of years (2, 3, 5), and your monthly payments will remain the same for that fixed period regardless of any interest changes in the market. The advantage is that you have peace of mind that your monthly payments will remain the same. The disadvantage is that these rates can be slightly higher than the variable-rate mortgages, and you won’t benefit from any drops in the interest rates. You are tied into the deal, and if you want to leave the deal, there are usually some early repayment charges, which will vary with different lenders but will be specified to you at the time of the mortgage application.

Variable rate mortgage: With this type of mortgage, the rate can change at any time, but it is usually a Bank of England base rate change. Every lender has a standard variable rate (SVR), and any variable rate products will rise or fall in line with this rate change. Even at the end of a fixed-rate product, your mortgage will revert to the lender’s standard variable rate. The advantage of having variable mortgages is that you can reap the benefits of any rate drop.

There are different types of variable rate products as below:

Discount mortgages: this is a reduction on the lender’s standard variable rate; for example, a 2% discount on the standard variable rate of 5% gives you a rate of 3% per annum. These usually start off cheaper and will revert to the standard variable rate. If the lenders drop their SVR rate, you will benefit from the price reduction. Equally, if the rate goes up, your monthly payments are likely to go up too.

Tracker mortgages move in line with a nominated interest rate, which is usually the Bank of England rate. So if the base rate goes up by 0.25%, your rate will go up by the same, and vice versa. They are usually 2–5-year term deals; however, some lenders can offer a lifetime tracker that can last the life of your mortgage. You can benefit from any rate drops, but you will have to hike up your monthly payments should the rates change. There could also be some early repayment charges if you switch before the deal ends.

Capped rate mortgages: This is a variable rate mortgage with a ‘cap’ or ceiling on how high the interest rate can rise. There is certainty that your payments won’t go up above a certain level, and you can still benefit if the rates come down. The ‘cap’ tends to be set high, so it benefits people who expect the rates to get a lot higher.

Offset mortgages: With this mortgage, your savings are linked to your mortgage. You pay interest on the mortgage amount less the amount you have saved. For example, if you had a £300,000 mortgage and £30,000 savings in your savings account, the savings amount would be deducted from the mortgage balance (300,000–30,000). So you pay interest on the balance of £270,000. So instead of earning interest, you avoid paying interest on £30,000. You can still access your savings, and the more you offset, the quicker you repay your mortgage. As you don’t earn interest on your savings, you don’t pay tax, which could potentially be a good saving, especially if you are a high-rate taxpayer. The rating for this type of mortgage tends to be higher than other deals.