Mortgages Explained – a guide to what’s on offer

By Becca Talbot
becca.talbot@consumerchoices.co.uk

When it comes to mortgages, the list of what’s available is endless. Banks and building societies are continuously updating and expanding the range of mortgages they offer, so shopping around to find the right one for you can be a bit daunting.

The most important things to consider when choosing a mortgage are how you’re going to pay back the money you borrow and how you’re going to pay the interest on that.

Whether you’re looking to buy a new house, or if you’re thinking about changing your current mortgage deal, our guide will explain everything you need to know about what’s on offer at the moment.

Mortgages Available

There are two categories of mortgage:

Repayment mortgages
Interest-only mortgages

Use our mortgage comparision service to help you work out the best kind of mortgage for you, or use our mortgage calculator to work out your monthly repayments.

Repayment mortgages	Interest-only mortgages
Make monthly repayments for an agreed period of time (the term) until you’ve paid back the loan and interest. This is considered the least risky mortgage type, as well as the easiest to understand.	Make monthly repayments for an agreed period, but this will only cover the interest on your loan. You’ll normally have to pay into another savings or investment plan each month as well, to pay off the loan by the end of the term.

When you take out a mortgage, as with any debt, you will have to pay back the money borrowed, plus interest. Mortgages differ with the options of repayment they offer.

There are six main ways that you can pay back your loan:

Our guide explains the different types of mortgage repayment, and weighs up the advantages and disadvantages of each.

At the end of the guide we recommend the best way to ensure you get the right mortgage for you.

Fixed Rate Mortgage

With a fixed rate mortgage you’ll pay a set amount of interest for an agreed period; you’ll know exactly what you’ll be paying back each month. When the fixed period ends you’ll usually move to the mortgage provider’s standard variable rate.

"...Banks and building societies are continuously updating and expanding the range of mortgages they offer..."

Pros and Cons

These are ideal if you’re budgeting, or if you think the Bank of England’s rates might increase.
There are penalties if you pull out of the term early, so this mortgage repayment method wouldn’t suit someone who may want to pay off their mortgage early.
If the Bank’s interest rates drop you’ll be tied into your set higher rate until the end of the agreed period.

Example:

Natwest offer a 2-year purchase fixed-rate mortgage at 5.89% for the initial period. You can choose to pay off capital and interest, interest only or a combination of the two, whatever suits you.

Back to the top

Flexible Rate Mortgage

Flexible rate mortgages, sometimes called variable mortgages, have been developed to cope with changes that could occur in the borrowers financial circumstances (for example, job loss). They’re designed to allow you to alter your repayments to suit your situation.

The sort of features that these mortgages include:

monthly overpayments (so you can reduce the term and save on interest)
reducing/stopping repayments during times of financial hardship
payments over 10 months instead of 12 months
payments every four weeks, instead of at the end of each calendar month
lump sum payments

The interest rate that applies is governed by the Bank of England interest rate, which can fluctuate. Any unpaid interest will be added to the outstanding mortgage and any overpayment will reduce your outstanding mortgage.

Pros and Cons

A flexible rate mortgage would suit buyers who feel they may want to pay a little extra each month without being penalised.
The majority of flexible rate mortgages charge interest daily or monthly, so in effect if you pay back more than the set repayment each month, you can reduce your term and save money.
If you want your repayments to be a set amount each month, if you were on a budget for example, this may not be the best mortgage plan for you.

Back to the top

Base Rate Tracker Mortgage

This type of mortgage has an interest rate that tracks the Bank of England’s base lending rate. Mortgages of this sort can last for a few years, reverting to the lender’s standard variable rate after that, or they can be for the whole mortgage term, known as a lifetime tracker.

Buying a new home

Pros and Cons

If you’re generally optimistic about the long-term prospects for interest rates, then a tracker mortgage may be worth considering. When the Bank cuts its base rate, you’re lender will cut your rate by the full amount, straight away. Whereas, if you had a variable rate mortgage, your lender may wait a bit longer before it cuts your rate, and when it does cut it, it may not be the full amount.
If you’re on a tight budget or feel you won’t be able to manage with higher monthly payments, because if the Bank raises its rate, yours will go up by the same amount and you’ll have to find the extra money each month.

Example:

Alliance & Leicester offer a Premier 2 year Base Rate Tracker mortgage deal for existing Premier and Premier Direct Current Account customers taking out a new mortgage. Repayments are lower for the first two years, with a rate of Bank of England Base Rate +0.89%, and after that the Bank’s rate +1.49% for the remainder of the term. The repayments are flexible - you can overpay, and with the overpayments you build up, you can borrow money back, take payment holidays, or pay less in some months.

Back to the top

Offset Mortgage

Many offset mortgage deals allow you to link credit cards to your current account, or to link mortgages, credit cards, savings and loans together. Although all the accounts remain separate and can be managed separately, as an offset mortgage holder you’ll benefit from reduced interest payments.

How an offset mortgage works:

If you have £20,000 worth of savings in a savings account and a mortgage of £100,000, you can apply for an offset mortgage account and pay interest only on the difference, which in this example is £80,000.

Pros and Cons

If you feel this is the best product for you, it’s worth looking at the benefits and drawbacks of the various accounts offered. For example the mortgage deal may be right, but you may get a better deal on a different current account.
It’s only worth considering an Offset mortgage if you have a healthy amount of credit in your other accounts.

Example:

Woolwich offer an Offset mortgage at 6.2% APR, of which you can borrow 80% of the value of your home and has no early repayment charges.

Back to the top

Buy To Let Mortgages

Mortgage providers now offer loans for properties that have been bought to let, i.e. not to live in as your house, but to rent/let out to tenants. Charging tenancy should cover the mortgage repayments.

Earning money through letting a property is seen as a good investment by some, and has become popular over the last few years.

As with all mortgage deals, there are things you need to consider before buying a property to let:

Make sure the property is in a sought after area for rentals, such as a University town for students, or in the city suburbs for commuters
Try to avoid long periods where the house stands vacant, the time between tenants where you’ll receive no rental income, because this could work out as a loss.

Most high street banks and building societies offer a buy to let mortgage product. And independent mortgage brokers will also be able to recommend mortgage arrangements which aren’t available on the high street and which will meet your buy-to-let mortgage requirements more accurately.

Back to the top

Discounted Rate Mortgage

With this type of mortgage, the borrower is offered a discount on the lender’s standard variable rate for a set period. For example, if the SVR is 5%, your rate could be 4%, giving you a 1% discount.

As with the Flexible Rate mortgage, you could potentially benefit from lower payments, although still run the risk of your repayments going up.

Remember that whilst discounted rates are usually the lowest rates in the market at any given time, after the set period the interest rate will go back to the lender’s standard variable rate.

Back to the top

Our Recommendation

We suggest that before you apply for any mortgage, ask yourself, and your potential mortgage provider these ten questions:

What is the best type of mortgage for me?
How can I tell which mortgage rate is best for me?
How much can I afford to borrow?

What kind of repayments should I make?

Can I make lump sum payments if I need to?

Are there penalties for making early repayments?

Does the mortgage come with insurance?

What other charges will I have to pay?

What happens if I can’t pay?

What about the small print?

Chris Eagle, from CreditChoices.co.uk says: “Given the current financial climate, it’s advisable not to overstretch the amount you’re planning to borrow. You should budget for higher interest rates, so you’re prepared for the worse. And it’s always worth speaking to an independent mortgage advisor, as buying a house is not something you should rush into.”

Compare mortgages, or work out how much you can afford with our Mortgage Calculator.

Email a friend

Text size