Types of Mortgages

Types of Mortgages

In this article, I’ll be explaining what a mortgage is and the different types of mortgages you can find. Each type has their own advantages and disadvantages, so choosing the best one for your circumstances can be very difficult. If, at the end of this article, you’re not sure about what would work best for you, the best thing to do would be to talk to a mortgage advisor.

Simply put, a mortgage is a loan that you use to buy a property. When you’re buying a house, you normally have to put down a deposit, usually at least 5% of the property’s value. The remainder of the money has to be borrowed from a third party lender, which can be a bank, a building society, or various other sources.

The mortgage will then be repaid over a certain number of years with interest added on.

What are the types of mortgages

There are two main types of mortgage. The first, and most common of these are repayment mortgages. This means that over the full term of the mortgage, you will be paying back the loan as well as a bit of interest on top of that. 

The other type of mortgage are interest-only mortgages. This is when you only pay the interest on the loan each month. However, at the end of the mortgage term you have to have a way to pay off the full amount of the mortgage. This is called an exit plan.

Sometimes it can be possible to find a mortgage that is part repayment, part interest-only. However, this is very rare.

Within these two main mortgage categories, there are several different types to choose from. The most common of these are fixed-rate mortgages, tracker mortgages, discount mortgages and offset mortgages.

Fixed-rate mortgages

Fixed-rate mortgages are mortgages which have the interest rate guaranteed to stay the same for a set amount of time. This way you know exactly what your mortgage repayments will cost you, which can offer peace of mind. 

You can fix the interest for different lengths of time depending on your circumstances. The most common are 2 or 5 years of fixed interest. However, you may be able to get a fixed-rate mortgage for as short as 1 year, or up to 15 years. But these offers are much rarer.

Once your fixed-rate mortgage term finishes, your lender will switch you onto a standard-variable-rate (SVR) mortgage. Each lender sets their own SVR, but generally they have much higher interest than fixed-rate mortgages. This is why it is important to explore your options at the end of your fixed-rate mortgage term. One route you can take is to remortgage onto a new deal with your lender, or switch lenders altogether. You can arrange your remortgage up to six months before your fixed-rate term ends.

Tracker mortgages

A tracker mortgage is when the interest rate you pay on your loan follows an external rate plus a set percentage. This external rate is usually the Bank of England base rate. This means if the base rate increases or decreases, then so will your interest payments for your mortgage. But, some tracker mortgages come with a “collar”. This means that the interest rate you pay can only fall to a set amount. So, if the collar is set at 2% interest, your interest rate cannot fall below that, even if the base rate falls. Some tracker mortgages also come with a cap. This means that your repayments can’t be more than a set rate. This can sometimes mean that your starting interest rate is higher though.

Discount mortgages

A discount mortgage is a loan where the interest rate is kept at a set amount below the lenders standard variable rate (SVR). The interest rate is either kept at this level for a predetermined time period, or for the whole mortgage.

This means that if your lender’s SVR is 5%, and your discount rate is 1%, you would be paying 4% interest on your monthly mortgage repayments. But that means that if the SVR increases by 2%, your interest rate will also rise by 2%. 

One big disadvantage of discount mortgages is that the SVR is set by each lender. This means that the SVR can change at any time and by any amount. However, if the SVR stays stable for the duration of your mortgage, they can represent an attractive option. 

Offset mortgages

This mortgage type is when the balance of a linked savings account is subtracted from the amount of the mortgage you pay interest on. This means you could pay less interest each month, or pay off your mortgage quicker. For example, if you have a mortgage of £200,000, and you linked your mortgage to a savings account with £20,000, you would only have to pay interest on £180,000. However, you would still have to pay off the full amount at the end of the mortgage term.

Often, offset mortgages come with higher rates than standard repayment mortgages. This could go some way to reducing the benefits you may see. When you couple that with the fact that you normally won’t earn interest on money held in linked accounts, it may make more sense to take out an ordinary repayment mortgage, and open a high-interest savings account alongside.

Factors that could affect your choice of mortgage

There are some very important factors that may affect your choice of mortgage. First of all is your deposit. The more money you are able to put forward as a deposit, the more likely you are to get favourable mortgage terms that could take the form of lower interest payments. Essentially, the more money you use as a deposit, the more money you could end up saving in the long run.

Secondly, the type of property you are looking to buy. This means whether you’re looking at buying a house, flat, new-build or various other property types.

There is also what you want your mortgage conditions to be. This includes how long you want to be paying the mortgage for, also known as the mortgage term. It also includes how much you can actually afford for your monthly mortgage payments.

Finally, whether or not you are taking advantage of any government schemes can influence your mortgage. There are loads of schemes available such as the Help to Buy, Right to Buy, Shared Ownership and more, so make sure you do your research to see if they can help you.

If you aren’t sure about many of these aspects, a mortgage broker can help you sort it out and give you advice on how best you should move forward. The different types of mortgages each have different characteristics, so make sure you choose the best option for you.