Finding the right type of mortgage can save thousands of pounds over the term of the loan, so it’s worth taking the time to understand your options before going ahead.
There are two main decisions:
- Whether to choose a fixed-rate (where your monthly payments are the same) or variable (which could go up or down).
- Whether to repay the mortgage over time or only cover the interest.
Interest-only and Repayment mortgages
What’s the difference? Well, repayment mortgages are a bit like swimming (hard work, but you’ll eventually get there) and interest-only mortgages are like treading water (fine for a while, but you don’t really move forward).
Repayment mortgages are the most common type. You borrow the money, then make a regular payment every month (the capital along with interest) until you’ve paid back the debt. As long as you keep to the payment plan, you are guaranteed to pay off the mortgage at the end of the term.
Interest-only mortgages cover only the interest part of the loan. This means that you never pay off the mortgage or reduce the capital. The upside is that your monthly payments will be much lower, but the downside is that you have to pay off the mortgage in full at the end of the term or switch to another mortgage.
Fixed-rate and Standard Variable-rate mortgages
The choice between a fixed-rate and a standard variable-rate mortgage basically comes down to your relationship with risk. Before we get into that, let’s cover the basics.
The ‘rate’ is the interest rate percentage charged by the lender. If you have a repayment mortgage, the interest is included within the monthly payment alongside chipping away at the capital.
The interest rate offered depends on several variables including market conditions and your LTV (loan to value ratio), which is the amount you need to borrow in relation to the value of your property.
This is when the rate is fixed for the initial period of the mortgage (usually between 2-7 years). The benefits of a ‘fixed’ rate is that it’s guaranteed not to change, which can help with budgeting and peace of mind against spikes in interest rates. The downside is that, if interest rates drop, you might be locked in at a higher rate.
At the end of the initial period, you’ll be switched to the standard variable rate (SVR). At this point, you can either continue with the variable rate, get another fixed-rate or variable mortgage with your current lender, or remortgage with a different lender.
Standard variable-rate mortgages (SVR)
The Bank of England base rate somewhat influences variable rates, but lenders can set their SVR at whatever they want. This means that your rate could go up or down at any time, so it’s worth keeping your eye out for deals.
If you have a head for numbers, research by Statista shows how the average interest rates for fixed-rate vs. variable-rate have performed over the last decade.
Other variable-rate mortgages
If you’re looking for more flavours of variable-rate, there are two other types of mortgage that you might see floating around the internet:
Unlike an SVR mortgage, a tracker mortgage is tied the Bank of England base rate and then adds a fixed amount on top. For instance, the base rate plus 2%. Just like an SVR, your payments can go up and down from month to month depending on whether the base rate changes.
This is when the lender agrees to offer a discount (for instance, 1%) on their SVR. The rate can go up and down, but the benefit is that you have a special discount on that rate for an agreed period of time.
That’s about all you need to know. However, lenders do have a few other products with additional bells and whistles. Here’s a quick overview of some other terms you might hear and what they mean:
- Capped rate mortgages: A variable mortgage with a cap on the interest rate to stop it rising past a certain percentage.
- Cashback mortgages: When a lender gives you a cash reward for taking out the mortgage. The downside is that the interest rate is often not the most competitive.
- Flexible mortgages: You can agree to overpay and underpay and even pause payments, giving you some flexibility over how you manage the purse strings throughout the year.
- Offset mortgages: If you have a savings account and a mortgage set up with the same lender, the lender might arrange an offset mortgage and count your ‘savings’ as part of your capital. So, if have a mortgage of £200,000 and £20,000 in the savings account, then you will only pay interest on £180,000. The benefit is that you can dip in and out of the savings pot.
Remember, the main decisions are whether you want to repay the mortgage or only the interest, and whether you want to fix the rate or risk it going up and down. Also think look ahead to predict if your income is likely to change and how you would manage if interest rates went up. If you’re still unsure about which is the best mortgage for you, we recommend speaking to an independent mortgage advisor who can help weigh up your situation and narrow down your options.
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