For many, a mortgage is one of the largest financial commitments they’ll ever make. So, when you’re looking at taking out a mortgage for your home it is important that you have all the information you need to help you choose the right type of mortgage for you.
But what are the different types of mortgages available to you, and which options are most appropriate?
What is a mortgage?
A mortgage is a long-term loan used specifically for the purchase of property or land.
Mortgages are considered secure loans, as they are secured against the value of your property until you’ve paid off the full amount. This means that if you fail to make your mortgage payments and the mortgage falls into arrears, your mortgage lender has the right to repossess your property to settle the outstanding debt.
The length and monthly repayment amount of your mortgage will depend on the terms of your mortgage, with one of the main factors being the type of mortgage you have.
How do you repay your mortgage?
When taking out a mortgage, the first choice you will be faced with is the repayment option. This can be broken down into two main categories; repayment or interest-only.
Repayment Mortgages
The most traditional type of mortgage is a repayment mortgage, whereby the monthly payment you make to your lender goes towards paying off the capital and the interest on your loan.
The key benefit to this type of mortgage is that your monthly payments go towards building equity in your property. Practically, part of each mortgage payment goes towards reducing your mortgage balance with the lender, in turn decreasing your loan to value ratio and increasing your equity in the house.
The downside to repayment mortgages, however, is that your monthly repayments will be larger than those of an interest-only mortgage on the same rates.
Interest-Only Mortgages
Unlike repayment mortgages, interest-only mortgages only require you to pay the interest each month. While this means you’re paying much less each month during your mortgage term, it also means that at the end of this period your equity in the property will only have grown should the value of your property have risen. It is important to note that at the end of your selected mortgage term the full amount of your mortgage loan will still be owed to your lender.
In order to qualify for an interest-only mortgage, lenders will require you to have a method of paying off your outstanding loan at the end of your term (repayment vehicle). Examples of this include savings, investments or pensions or the sale of property should you plan to downsize in future.
However, it is possible to build equity during your interest-only mortgage term by overpaying. Any additional money paid over the interest payment goes towards paying off the mortgage capital and building equity.
While this may not seem practical for most, one example of interest-only mortgages being a strong option is in the case of landlords who may be happy to substitute house equity for monthly income from their property, but do not want high monthly costs at times where there is no tenant in the property.
It is important to note that in recent years, stricter criteria has been introduced on residential interest-only mortgages, and as a result this repayment type may not be available to all.
What are the different types of mortgages?
When considering the best mortgage for you, there are two main types of mortgage to consider: fixed-rate and variable-rate.
Fixed-Rate Mortgages
Fixed-rate mortgages are the most common type of mortgage in the UK. They provide a set timeframe during which your lender guarantees an agreed-upon interest rate, giving you peace of mind that you know exactly how much you’ll have to pay towards your mortgage each month. This period typically ranges from two to five years, though it can sometimes be even longer.
After the agreed-upon period has expired, your rate will automatically be switched to your lender’s standard variable rate (SVR), which may be significantly higher than what you were originally paying and fluctuates in line with the market. Often, it’s more financially viable to remortgage and get a better deal.
Fixed-rate mortgages are particularly attractive at times when interest rates look as though they may be on the rise, and tend to be extremely popular with first-time buyers or young families who may have stricter budgets. However, fixed-rate mortgages do have some downsides; borrowers can only make a certain percentage (usually around 10%) of overpayments on your mortgage without being hit with early repayment charges (ERC). Additionally, if you decide to switch to a different mortgage before the fixed term period is finished, you’re likely to face a penalty from your lender.
Variable-Rate Mortgages
As the name suggests, a variable-rate mortgage can see its interest rates shift at any time, usually in response to interest rates set by the Bank of England. However, it’s worth noting that there are several types of variable-rate mortgages available. These include:
- Standard Variable Rate (SVR): interest rates for SVRs are set by the lender, and are influenced by (but not directly linked to) the Bank of England. This means that the amount you pay may fluctuate in line with the base rate. When the base rate falls, you may pay less. When the base rate rises, you may pay more. However, one the benefits of an SVR is that you can overpay or leave your mortgage for another and not face any penalties for doing so.
- Discount Standard Variable Rate: similar to an SVR, except that these mortgages provide you with a discount for a limited amount of time. The size of the discount is fixed in line with the SVR. Discount mortgages are often used as introductory products to entice new customers.
- Tracker: directly affected by the Bank of England (BoE), a tracker mortgage will be equivalent to the interest rates set by the BoE, plus a margin set by your lender.
- Capped-rate: these mortgages often follow the same format as SVRs, except that they have a collar on how high the interest rates can rise. Conversely, they may also have a collar at the other end, preventing the rates from falling below a certain level.
Specialist mortgage types
Aside from the standard fixed-rate and variable-rate mortgages, there are several more specialised types of mortgages available, often designed for a specific type of home buyer. Examples of these include:
Offset Mortgages
An offset mortgage links your mortgage to one of your savings accounts and is used to lower the interest amount on your repayments.
As an example, if you have £15,000 in your linked account and have a mortgage for £250,000, you’ll only pay interest on £235,000 of your loan.
You’ll still have to repay the full amount of your loan, and interest rates tend to be slightly higher than for other repayment mortgages.
It is also worth noting that while your linked savings account will help make your mortgage payments cheaper, you are not able to earn any interest on the savings against which your mortgage is offset.
Buy-To-Let Mortgages
Aimed at prospective landlords, buy-to-let mortgages tend to be based on the amount of rent that you’re likely to receive rather than on your personal income. Typically, lenders will ask for a deposit equal to 25-40% of the property’s value, and will want your annual rent to be worth at least 125% of your mortgage repayments.
If you are interested in taking out a buy-to-let mortgage, you can find out more information by visiting our dedicated buy-to-let mortgages page.
Help to Buy and Shared Ownership Mortgages
Help To Buy ISAs:
Set up by the government to encourage more first-time buyers, the Help To Buy scheme makes it easier to buy your first home. This is done through a Help To Buy ISA, which is designed to supplement your deposit.
It is important to note that while preexisting Help to Buy ISAs can be used to aid in the purchase of a new home, it is no longer possible to open one as the scheme has come to an end.
Lifetime ISAs:
Lifetime ISAs are still available through the government, and are a way of supplementing your savings which can be used towards your first house purchase. Savers can put away up to £4,000 each year into a Lifetime ISA, and the government will contribute an additional 25% to anything saved. For example, if you save £1,000 in a year, the government will contribute an extra £250. At the time of writing, any growth in a Lifetime ISA is tax-free.
Lifetime ISAs can only be opened by savers between the ages of 18 to 39, and government supplementation stops when you turn 50.
Shared Ownership Mortgages:
Alternatively, you can opt for a Help to Buy shared ownership, where you buy a share of between 25% and 75% of a house’s value, before paying rent on the remaining share.
How to choose the right mortgage for you
Finding the right mortgage for you can feel daunting, but below are a few tips to help you with your decision:
- Talk to a reputable mortgage broker
- Decide how much you can put down on a deposit
- Decide how much you can afford in monthly repayments
- Determine whether you can afford to have your monthly repayments rise through a variable mortgage, or if you’d prefer to play it safe with a fixed-rate mortgage.
- Carry out a credit score check and ask your broker how it will affect your mortgage
Transparent mortgage advice with Cooper Associates
At Cooper Associates, we know it can be difficult to find a mortgage that works for you. For that reason, we take pride in delivering a fully transparent and personal service. To find out more about how we can help, get in touch with us today.
