Mortgage Guides

Mortgages explained – a guide to what’s on offer

By Emma Lunn and Becca Talbot becca@consumerchoices.co.uk

When it comes to mortgages, the list of what’s available is almost endless. We're here to help with a simple guide to the different types of mortgages available... (Updated 15/10/09)

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 both the money you borrow and the interest payable on that amount.

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 ways to repay your mortgage:

Repayment
Interest-only

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 seven main types of mortgage:

These categories are not all mutually exclusive. So, for example, you could get a flexible tracker mortgage or an offset fixed-rate mortgage.

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 mortgages

With a fixed-rate mortgage you’ll pay a set amount of interest for an agreed period and 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.

Pros and Cons

These are ideal if you’re budgeting, or if you think the Bank of England base rate might increase.
If the base rate drops you’ll be tied into your set higher rate until the end of the agreed period – so you might miss out on the opportunity to have cheaper payments.
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.

Guide to fixed-rate mortgages

Variable-rate mortgages

With a variable rate mortgage your payments move up or down at the lender's discretion. Many variable rate mortgages are set at the lender’s standard variable rate (SVR). The lender may not reduce, or may delay reducing, its SVR even if the Bank of England rate goes down.

Pros and Cons

Usually you can leave your lender without any penalties.
SVRs generally move with the Bank of England base rate. So if the lender decides to increase the rate your monthly payments will increase. However there are no guarantees that the lender will reduce the rate you pay if the base rate falls.
This type of mortgage may be expensive compared to other deals.

Guide to variable-rate mortgages

Flexible mortgages

Flexible 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 things that these mortgages allow include:

Monthly overpayments (so you can reduce the term and save on interest).
Reducing/stopping repayments during times of financial hardship - but you normally need to have overpaid a certain amount to use this feature.
Payments every four weeks, instead of at the end of each calendar month.
Lump sum payments.

Interest rates on flexible mortgages can be either fixed or variable.

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 if you pay back more than the set repayment each month, you can reduce your term and save money.
Interest rates on flexible mortgages can be higher than on other types of mortgage.

Tracker mortgages

This type of mortgage has an interest rate that tracks the Bank of England’s base 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. Each month the Bank of England monetary policy committee (MPC) meets and decides whether to increase, decrease or hold the base rate at its current level.

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 of England cuts its base rate, your 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.
There is always the risk that interest rates will rise and if they do you’ll be faced with higher payments.

Guide to tracker mortgages

Offset mortgages

Many offset mortgage deals allow you to link your mortgage to you current account and/or savings deposits. 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 competitive, but you may be able to 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.

Guide to offset mortgages

Buy-to-let mortgages

Mortgage providers offer loans for properties that will be been purchased to rent as opposed to being occupied by the owner. The tenants’ rent should cover the mortgage repayments.

Earning money through letting a property is seen as a good investment by some, and became very popular during the property boom.

As with all mortgage deals, there are several 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
Make sure you vet your tenants thoroughly to make sure they can afford the rent. If you take a deposit from them you’ll need to place it in a recognised tenancy deposit scheme.

Some high street banks and building societies, as well as specialist lenders, offer buy-to-let mortgages. Also independent mortgage brokers will be able to recommend mortgage arrangements which aren’t available on the high street and which may meet your buy-to-let mortgage requirements.

Discounted-rate mortgages

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 variable-rate mortgages, 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.

Guide to discounted-rate mortgages

Our recommendation

We suggest that before you apply for any mortgage, ask yourself, your potential mortgage provider, and ideally a whole-of-market mortgage broker, 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, commercial manager at 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 adviser. Buying a house is not something you should rush into.”

Compare mortgages, or work out how much you can afford with our mortgage calculator.