Mortgage Guides

The seven types of mortgage

Updated: Wednesday 5 October, 2011

By Martin Fagan news@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. 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 comparison service to help you work out the best kind of mortgage for you, or use our mortgage calculator to work out your monthly repayments

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

• 1. Fixed-rate mortgages
• 2. Variable-rate mortgages
• 3. Flexible mortgages
• 4. Tracker mortgages
• 5. Offset mortgages
• 6. Buy to Let mortgages
• 7. Discounted-rate mortgages

1. Fixed-rate mortgages

With a fixed-rate mortgage you’ll pay a set amount of interest for an agreed period so that you know exactly how much you’ll be paying back each month. But fixed-rate mortgages don’t usually last for the entire term of your mortgage, so when the fixed period ends you’ll be put onto your provider’s standard variable rate (SRV).

Fixed-rate mortgages are ideal if you’re budgeting, or if you think the Bank of England base rate might increase. But if the base rate drops you’ll still be tied into your pre-defined higher rate until the end of the agreed period – so you might miss out on the opportunity of cheaper payments. ,/p>

Penalties will apply if you pull out of the term early, meaning fixed-rate mortgages aren’t suitable if you want to pay your mortgage off early.

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.

Read our guide to fixed-rate mortgages

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2. Variable-rate mortgages

On a variable-rate mortgage your payments rise and fall at the lender's discretion, with your repayments often set according to their SVR. Even if the Bank of England rate goes down, the lender’s SVR may not drop.

If the lender decides to increase the SVR, your monthly payments will increase. Normally you can remortgage on a variable-rate deal without any penalties, such as exit fees or early repayment charges.

This type of mortgage may be expensive compared to other deals.

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.

Read our guide to variable-rate mortgages

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3. 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 sorts 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.

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4. Tracker mortgages

This type of mortgage has an interest rate that tracks the Bank of England’s base rate. Mortgages of this sort last for a fixed term, such as two, three or five years, reverting to the lender’s SVR 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 immediately cut your rate by the full amount. 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.

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5. Offset mortgages

Many offset mortgage deals allow you to link your mortgage to your 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.

Read our guide to offset mortgages.

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6. Buy-to-let mortgages

Mortgage providers offer loans for properties that will be been purchased to rent to tenants as opposed to being occupied by the owner. The tenants’ rent should cover the mortgage repayments and all the other expenses, such as council tax.

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. Independent mortgage brokers will also be able to recommend mortgage arrangements which aren’t available on the high street and which may meet your buy-to-let mortgage requirements.

As a rule, buy-to-let mortgages are expensive to service as lenders charge potential landlords higher rates of interest to compensate for what they perceive to be a riskier borrower. Also, buy-to-let mortgages tend to be low loan-to-value, which means borrowers will need a deposit of at least 80% of the property’s value, in some case 60%.

Read our guide to buy-to-let mortgages

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7. Discounted-rate mortgages

With this type of mortgage, the borrower is offered a discount on the lender’s SVR 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, while 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 SVR.

Read our guide to discounted-rate mortgages.

Compare mortgages.

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Our recommendation

We suggest that, before you apply for any mortgage, ask yourself, your potential mortgage lender , and ideally a “whole of market” mortgage broker, the following 10 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.”




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THINK CAREFULLY BEFORE SECURING ANY DEBTS AGAINST YOUR HOME.
YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON A MORTGAGE OR ANY OTHER DEBT SECURED ON IT.