Different Types of Mortgages Explained
Finding the right type of mortgage can feel like a minefield! There are several considerations to be made and the kind of mortgage you go for will vary depending on your specific situation.
How do mortgages work?
Mortgages all work in a similar way: you simply pay back what you have borrowed, with added interest. However, there are different mortgage types on the market, with different amounts of interest payable.
Mortgages have two main elements to them:
- Capital: Which is the money you borrow to buy your property
- Interest: Which is the interest owed to the lender on the money you borrow
There are two main ways that interest is paid:
Repayment Mortgages
This is the most prevalent kind of mortgage within the United Kingdom. On repayment mortgages, the capital (the money you borrow) plus the interest on the capital are paid back each month. Generally, the amount of capital and the interest are both fixed at the start of your mortgage term, generally between two and five years. After the initial fixed period, payments will either go up or down, depending upon the terms of the mortgage. One of the biggest benefits of a repayment mortgage is that it means that you will one day fully own your entire property, so long as you maintain the monthly payments.
Interest-only Mortgages
With interest-only mortgages, you only pay back the interest on the loan, not the capital. When you have an interest-only mortgage, it will be necessary to find another way to pay back the capital on the property at the end of the mortgage term. This is often done by selling the property. When you come to the end of the term, you will need to pay the original loan amount in a single lump sum. Interest-only mortgages were initially created for homebuyers who knew that their incomes would go up over time and were planning on selling their home before the end of the term of their interest. Unfortunately, many borrowers couldn’t sell their homes, or refinance when the term came to an end, which has meant that interest-only mortgages are now far less common.
What are the Different Types of Mortgages Available?
There are different mortgages available to suit different people as people have different needs.
Fixed Rate Mortgages
Fixed rate mortgages have an interest rate which has been set for a fixed period of time, which is normally somewhere between two and five years. The benefit of this is that your monthly payments will remain the same, even if the interest rates go up. This means that you can be reassured knowing exactly what your outgoings will be each month. On the downside, it can mean that when the rate ends, the interest rate will then move over to your lender’s standard variable rate, which may be higher.
Tracker Mortgages
The interest rate on tracker mortgages is determined at a set percentage on top of the Bank of England’s base rate. If the base rate was at 1.5% and you’re/your the interest rate on your tracker mortgage was 3.5%, then the interest rate you pay will be 5%. The benefit of tracker mortgages is that they tend to start off with a lower interest rate than fixed mortgages, so your monthly outgoings will be less, but the compromise for a lower rate is the exposure to rate changes, the interest rate tracks the bank of England base rate, should the bank of England base rate go up, your interest rate will track that increment, and therefore your mortgage payments shall increase. After the initial period (which is normally two to five years), the interest rate will go back to the lender’s standard variable rate.
Discount Rate Mortgages
A discount rate mortgage is when the interest rate has been discounted at a set percentage below the mortgage providers standard variable rate. As an example, if the lender’s standard variable rate is at 6%, then a borrower with a pre-set discount of 2%, will have an interest rate of 4%. The benefit of discount mortgages is that they tend to start off with a lower interest rate than fixed mortgages, so your monthly outgoings will be less, but the compromise for a lower rate is the exposure to rate changes, the interest rate tracks the mortgage providers standard variable rate, should the mortgage provider decide to change their standard variable rate, your interest rate will track that increment, and therefore your mortgage payments shall increase. After the initial period (which is normally two to five years), the interest rate will go back to the lender’s standard variable rate.
Capped Rate Mortgages
Capped rate mortgages have similarities with tracker mortgages as the interest rates are set at a specific percentage above the Bank of England base rate. The difference being is that with a capped mortgage, there is a ‘cap’ on what the interest rate can go up to. For example, you can have a mortgage with a 1% discount and a cap of 4.5%. If the standard variable rate was 5%, then you will pay 4% but after a year, if the lender raised their standard variable rate to 6%, your cap would mean that you still only pay 4.5%.
Offset Mortgages
Offset mortgages mean that your savings are offset against the balance of your mortgage, so you only pay interest on the difference. So, if you have a £100,000 mortgage and £20,000 in savings, then you only pay interest on £80,000. Offset mortgages are the ideal solution if you want to minimise the interest you pay throughout your mortgage, as well as reducing your debt.
Would you like the best mortgage deal for you?
Whether you want to buy your first home, remortgage your current property or step up the ladder, we can help you!
At Transparent Mortgage Services we assist you, whether you’re buying your first home, staying put or moving up the ladder. We will find the most competitive interest rates and best mortgage deal that suits your needs. Contact us today by phone on 01424 444597, or by email on info@tms-fs.co.uk.
