When purchasing a property, unless you have a very large sum of money in your bank account, it is most likely that you will need a mortgage, but how do you decide what type of mortgage to get? The different types and products on the market can be bewildering. In this guide we will take a look at the different types of mortgage and give some pros and cons for each type.
Repayment vs Interest Only
This is perhaps the first choice to make and there is a difference:
Repayment Mortgages
In this type of mortgage, the monthly payments cover all the interest and a portion of the actual loan amount itself. This means, that over the period of the mortgage the loan is paid off and as time progresses less interest is paid and more of the equity is paid. At the end of the mortgage term all the interest has been paid and the entire loan has been paid so the property is 100% yours. The disadvantage of this type of loan is that the monthly repayments are quite a bit more than interest only loans so can be a drain on the monthly financials. The positive is that, at the end of the mortgage, the property is yours with no more finances to worry about and you won’t owe the lender a penny.
Interest Only Mortgages
With this type of mortgage, all that is paid is the monthly interest. None of the actual loan is paid off. At the end of the mortgage period, the entire loan still needs to be paid off. The advantage of interest only mortgages is that they cost less every month as only the interest is being paid. This can make them more affordable. The main downside is that, at the end of the mortgage, the entire loan still needs to be paid off. This is typically achieved by selling the property and there is a risk that the market price of the property at that time is less than was originally paid and the difference would need to be paid for personally.
Fixed Rate vs Variable Rate
The next thing to look at is whether you want a fixed or variable rate mortgage and there are different types within these as well:
Variable Rate Mortgages
As it says the rate, that means the interest rate varies as the bank’s interest rates varies. This means that the monthly cost can go up and down as interest rates move and they are typically linked to the Bank of England interest rate. There are essentially 3 types of variable rate mortgage:
- Standard variable rate (SVR). This is the standard interest rate set independently by the lender. This does not need to be related to the Bank of England (BoE) base rate and is purely based on the lender’s own business practices. Typically, when a fixed rate deal comes to an end a customer will automatically revert to the lender’s standard variable rate. The downside of an SVR is that they are typically a higher rate than a fixed or tracker rate and as such the repayments are more expensive on a monthly basis. Also, it is hard to budget robustly as they can change on a month by month basis if the markets are volatile. On the plus side, there is no tie in to SVR mortgages, so if you are looking at moving or changing mortgages then there are no penalties for moving the mortgage. Another plus is when interest rates fall. Rarely, but sometimes, interest rates can fall below rates set for a fixed rate mortgage. These falls will be reflected in your payments as they will most likely reduce as interest rates fall.
- Tracker mortgages. These mortgages tend to be at lower rates and track, directly, the Bank of England base rate. Unlike the SVR mortgages, these are guaranteed to track the Bank of England base rate changes. They are typically the base rate plus a certain percent, e.g. 1%. So, if the BoE base rate is 2% your interest rate will be 3%. Tracker rates have the same pros and cons as SVR mortgages but they do not tend to have the advantage of having no penalties. As they tend to have lower interest rates than the SVR rate, they will have a fixed term within which moving mortgages might attract a penalty. One additional advantage here is that the rate tracks with the BoE base rate. For SVR mortgages any drops in the base rate are not always passed on.
- Discounted mortgages. These mortgages are typically based on the lender’s SVR and offer a discount for a fixed term against the SVR. So, they will move as the lender’s SVR changes, but will always be a lower rate, e.g. 2% lower. As an example, if the SVR is 5% and you are on a 2% discounted rate, your interest rate would be 3%. The disadvantages of this mortgage are that it can have varied monthly repayments, will likely have a tie in period within which any move will incur penalties and tracks the lender’s SVR rather than BoE base rate which tends to be higher.
When looking at variable rate mortgages check for any caps. This can be a low-end cap, i.e. the lowest interest rate that will be paid no matter what the BoE base rate does, but there could also be an upper end to the rate to be paid.
Fixed Rate Mortgages
These are exactly what they say on the tin. The interest rate is fixed for a period of time, typically 2, 5 or 10 years. Typically, the rate is lower than the lender’s standard variable rate, making them cheaper as far as the month-to-month payments are concerned. Saying that, the longer the term of the fixed rate, the higher the rate is likely to be. The added bonus is that the amount paid per month does not change over the course of the fixed rate term so budgeting is much simpler. Some of the disadvantages of fixed rate deals are: if the Bank of England base rates drop and you took out your mortgage when rates were relatively high, it is possible that the BoE base rate would be less than your fixed rate. Even if this happens, you pay the same amount and won’t see any savings. Fixed rate mortgages can often attract larger mortgage fees, typically around £1,000. This is more than would be paid for a variable rate mortgage. The final downside is that, if you need to move mortgages during the fixed term there is likely to be a fee to pay for terminating the mortgage early.
Green Mortgages
Green Mortgages are relatively new but they are aimed at incentivising a property owner to either buy an environmentally friendly property or to upgrade and existing property to be more sustainable. This is typically done by offering a lower interest rate. Typically, a home would need to have either an A or B EPC rating or would need to be upgraded and raise the EPC rating as required by the lender. These mortgages do incentivise greener homes and with these come lower utility bills which is a bonus. There is extra administration, though, especially when upgrading as you will need to prove the upgrades to the lender to keep the discounted rate. The main downside is that this market is in its infancy so there are only limited lenders in the market and the rates being offered aren’t always much better than either discounted rates or fixed rates.
There is no one answer as to which mortgage you should choose as it depends entirely on your personal circumstances. It is advisable to talk to an independent financial advisor or mortgage advisor about your circumstances and they will be able to help you obtain the right mortgage for you.
Disclaimer: Your home may be repossessed if you do not keep up repayments on your mortgage.
There may be a fee for mortgage advice. The actual amount you pay will depend upon your circumstances. The fee is up to 1% but a typical fee is 0.3% of the amount borrowed.
