The different types of mortgages explained
For many people, the dream of owning their own home is only possible via a mortgage, but how do you know which one would best suit you? Navigating the world of mortgages can be confusing, which is why we’ve put together this handy guide to get you started.
So, what is a mortgage? All mortgages work in the same basic way; you borrow money to buy a property and pay back the loan with interest. There are different interest rates, different ways to repay, time frames, charges and types, most of which can be discussed with one of our friendly advisers if you’re feeling stumped.
With a repayment mortgage, you repay some of the capital you’ve borrowed, plus interest, on a monthly basis. At the end of the period which is usually around 25 years, you’ll have paid off the mortgage and you’ll own the property outright. If you move within that time, you can potentially take your mortgage with you, or repay the original loan and take out a new one. Changes in the value of your house can give you a larger deposit and a better rate of interest if you do happen to move.
Interest Only Mortgages
An interest only mortgage does pretty much what it says on the tin – you just pay back the interest each month and pay back the money you’ve loaned at the end of the period with your savings. You can save the money any way you see fit or use inheritance, but you must be able to pay that money when the time comes. If not, you might have to sell the house. If your property value increases enough over the period you’re in it, you may be able to remortgage and pay off the debt with the money from the house. To be approved for this type of mortgage, you need to be able to show how you intend to repay the loan, but the benefit is that the monthly repayments are lower.
Fixed Rate Mortgages
Fixed rate mortgages are attractive to first-time buyers because the interest rate is fixed for a set number of years, meaning you know exactly how much you’ll be paying each month, regardless of changes in the market. The downside to this, however, is that if the mortgage rates drop, you’ll still be paying the same amount. As the time frame for this type of mortgage is shorter than a repayment mortgage, you’ll usually be put on the lender’s standard variable rate which will usually be higher than you’ve paid previously. You can however, apply for another fixed rate deal.
Variable Rate Mortgages
Each lender has a standard variable rate (SVR) mortgage, which is the most basic type. The interest rates change depending on mortgage rates, which are influenced by the Bank of England as well as other factors. The amount you pay can change each month, depending on the current rates; if rates are low, you’re in luck, if they aren’t, not so much.
Tracker mortgages move in line with a nominated interest rate (usually the Bank of England base rate). The actual mortgage rate you pay will be a set interest rate above or below the base rate. When the base rate goes up, your mortgage rate will go up by the same amount. And it’ll come down when base rate comes down.
Discount Rate Mortgages
Discount rate mortgages are similar to an SVR mortgage, but with discounted rates. They’re cheap, but as they’re linked to the standard variable rate, the amount you’ll pay will go up and down when the rate changes. One drawback is that the discount period only lasts around 2-5 years.
Capped Rate Mortgages
If you’re of the belief that mortgage rates are going to rise, you can opt for a capped rate mortgage, which means there’s a ceiling on how much you’ll pay. Capped rate mortgages aren’t always available from lenders due to the low mortgage rates in recent years.
As an incentive to attract potential clients, lenders sometimes offer cashback mortgages, whereby you’re given a percentage of your money back over time. It’s important to look carefully at the interest rate being charged, as well as any additional fees, as sometimes you can find better deals without the cashback incentive. They are beneficial, however, to people who might need a lump sum to spend on the house.
Offset mortgages are linked to a savings account and combine savings and mortgage together. Each month, the lender will look at how much you owe on the mortgage and then deduct the amount you have in savings. You pay mortgage interest just on the difference between the two. This means that you end up paying less interest, but that the mortgage rate is likely to be more expensive than other options. You still have access to your savings, but the more you offset, the quicker you’ll repay your mortgage. It’s generally a good option for people who have a lot of savings.
If you can only afford a 5% deposit, you may be at risk if house prices go down; even a 6% drop means you’re into negative equity. Because of this, lenders will usually charge a higher mortgage rate.
With a flexible mortgage, you can choose to pay more when you can afford it and can pay slightly less if you’ve overpaid previously. You can even take a payment holiday and miss a few payments altogether. Because of this, the mortgage rate will be higher than on other mortgage types. If you suspect you’ll run into payment problems in the future, this could be a good option for you.
Buy To Let Mortgages
Rather than living in a property, buy to let mortgages are for people who wish to purchase it but want to rent it out. The amount you borrow is based on the amount of rent you’re likely to receive, as well as other factors.
If you’re looking for advice on what is definitely a very complicated mortgage market, don’t hesitate to contact one of our friendly advisers. They can help you find the mortgage that’s right for you.