What types of Mortgages are there

How do you decide which type of mortgage to go for and where can you find the best deals? Let's talk about loans.

Key takeaways

  • With repayment mortgages, you own your home outright at the end of the mortgage term.

  • With interest-only mortgages the repayments will be lower, but you'll still need to pay the outstanding mortgage debt at the end of the term.

  • With fixed rate mortgages, your payments are the same every month, while with trackers your payments may fluctuate.

When you’re looking to buy a new home, the choice of mortgages available can feel overwhelming. 

Do you want a fixed rate where the monthly repayments stay the same or a tracker where the repayments can be lower but may fluctuate?

Let's take a look at the different types of mortgages available and where you can find the best deals.

1.    Repayment mortgages 

2.    Interest-only mortgages

3.    Fixed rate mortgages

4.    Tracker mortgages

5.    Standard variable rate mortgages

6.    Discounted rate mortgages

7.    Flexible mortgages

8.    Capped rate mortgages

9.    Offset mortgages


1. Repayment mortgages

A repayment mortgage allows you to repay a bit of the loan along with interest each month.

The main advantage with this one is that you’ll own your home outright at the end of your mortgage term.

Every time you make a payment, the amount you owe gradually reduces. That means your equity stake (that’s the percentage of your home that you own) increases.

Homeowners with larger equity stakes can qualify for lower mortgage rates, as the best interest rates are usually reserved for those borrowing 60% or less of their property's value.

You’ll also have a greater choice of mortgage products if you’re on a repayment mortgage, as they are the most widely available loans.


2. Interest-only mortgages

Under an interest-only mortgage, you only pay interest on the mortgage, you don’t repay the debt itself. 

The debt is then repaid instead at the end of the mortgage term. So if you borrowed £100,000 at the beginning, you'd still owe £100,000 at the end.

The good thing about interest-only mortgages is that the monthly repayments are a lot lower: a £200,000 interest-only mortgage at 2.5% over a 25-year term would be £417 a month, compared with £905 for a repayment mortgage.

However, borrowers would need to feel confident that they could repay the outstanding debt at the end of the term.

Interest-only mortgages are seen as higher risk by lenders, so they have stricter affordability criteria for them.

They’ll often only lend to people who have a large equity stake in their home, meaning first-time buyers may find it tricky to get one.


3. Fixed rate mortgages

Fixed-rate mortgages are a popular choice because the interest rate is guaranteed to stay the same for the length of the deal. 

That means you’ll know exactly how much you’ll need to repay each month, regardless of what happens to interest rates.

Mortgages can be fixed for one, two, three, five, 10 or even 15 years and lenders call this short-term special rate an 'incentive period’.

The interest rates on fixed rate mortgages tend to go up the longer you fix them for. But for the peace of mind they offer, if you can get a good rate, they can be worth doing.

Two-year fixed rate mortgages are available from 0.86% interest. That means for a £100,000 loan with a £10,000 deposit, your monthly repayments would be £333.

For the same loan and deposit, five-year fixed rate mortgages are available from 0.97%, meaning your monthly repayments would be £337.


4. Tracker mortgages

Tracker mortgages 'track' the Bank of England base rate, which is currently 0.25%. But they are usually set higher than the base rate. So you might pay the base rate plus 3% for example, making your mortgage interest rate 3.1%.

Tracker mortgages, like many mortgages, usually have an introductory deal period that lasts between two, five or 10 years. After that, you'd move onto the mortgage provider's standard variable rate.


5. Standard variable rate mortgages

Banks and building societies generally set their own standard variable rates. And they are often the most expensive mortgages available.

Right now, the best mortgage interest rates for first time buyers are around 2% to 2.5%, according to Moneyfacts. 

In contrast, the average standard variable rate, or SVR mortgage, is around 4.3%. 

If your mortgage moves over to the standard variable rate at the end of your deal, as many do, your outgoings will suddenly increase. And because it’s a variable rate, your lender can also change the SVR at any time.

Say you borrowed £100K with a 10% deposit at an interest rate of 2%. Over 25 years, your monthly repayments would be £381.

If you borrowed £100K with a 10% deposit at a standard variable rate of 4.3%, over 25 years, your monthly repayments would be £490. 

It’s much better to search for another mortgage deal when your one ends, than to put up with paying the standard variable rate.


6. Discounted rate mortgages

A discount mortgage is where the interest rate is pegged at a set amount below the lender’s standard variable rate (SVR). 

They can be set for a period of two years, five years or for the whole term of the mortgage. 

Like with variable-rate mortgages, discount mortgage repayments could change from month to month.

The interest rates on discount rate mortgages can begin at around 3.7%, according to Moneyfacts.  


7. Flexible rate mortgages

A flexible rate mortgage is like a mortgage with benefits.

Flexible rates give you the chance to overpay, underpay and even borrow money back from the mortgage.

Usually, you can only do the latter if you've already overpaid into the mortgage. And if you want to take a payment holiday, the same applies.

Do be aware that when you arrange a payment holiday with your provider, the missed payments are added to the rest of the mortgage. So afterwards, your monthly repayments will go up.

Some mortgages already have flexible features added in. 


8. Capped rate mortgages

Capped rate mortgages offer payment security because they have an interest rate cap, meaning your payments won't go above a certain amount.

However, they also work on a variable rate, so you'll benefit from lower payments when interest rates go down.

Capped rate mortgages operate at a higher variable rate than the best tracker and discounted deals, but that's because they offer security through the cap.

They’re usually offered as an introductory deal and you'll then move onto the lender's standard variable rate or tracker rate when the deal comes to an end.

However, once the deal does end, you're free to remortgage to a new one. 


9. Offset mortgages

Offset mortgages let you link your mortgage to your savings. 

The balance of your savings is used to offset the interest charged on the mortgage, which means you only pay interest on the mortgage balance minus your savings.

So, if you had a mortgage of £100,000 and £50,000 in savings, you would only pay the interest on £50,000 of the mortgage.

Your savings are still accessible, they just sit alongside your mortgage to save you interest.

Should I use a mortgage broker or go directly to a lender?

If you have good equity in your property and can easily afford the monthly repayments, you’re likely to be fine applying directly to the lender.

Mortgage brokers really come into their own if you only have a small deposit or need to borrow a high multiple of your income.

They can also be helpful if you’re a first-time buyer and aren’t very familiar with the mortgage application process. 

Mortgage brokers scour the market to locate the best deals for you and they often have access to exclusive rates.

You may need to pay a fee for their services, but some brokers are paid a commission from the mortgage lender instead.


Source: Zoopla December 2021