Taking out a mortgage is one of the most significant financial commitments you’re ever likely to make, so it’s crucial to understand what type of mortgage will suit you best.
Generally speaking, interest rates on mortgages represent the amount that you are being charged to take out a loan. The amount of interest that you pay will change over time, and it will also depend on the type of mortgage that you have.
We have put together a guide that outlines the different types of mortgages available to help you decide which one could be right for you.
Repayment mortgages
A repayment mortgage is a home loan where you repay a bit of capital, which is the amount you borrowed, and interest, each month. This is the most widely available type of mortgage in the current market, and this type of mortgage means you’ll make monthly repayments for an agreed period of time (known as the term) until you have paid back both the capital and the interest. This means your mortgage balance will decrease each month (as long as you keep up your payments), and the mortgage will be repaid at the end of your term. The term duration is typically 25 years. However, there are options from 6-months to 40 years through some lenders.
Interest only mortgages
An interest only mortgage allows you to pay just the interest charged each month for the term of the loan, not any of the original capital borrowed. You won’t have to repay the amount you’ve borrowed until the end of the term, meaning payments will be less in comparison to a repayment mortgage. However, overall, the total cost of an interest-only mortgage will be higher because you’ll be paying interest on the entire loan amount throughout the mortgage term.
Let’s say you borrow £200,000 on an interest only basis, over 25 years, at an interest rate of 3%.
If you repay the mortgage on a repayment basis, you will pay £948 a month.
If you repay the mortgage on an interest-only basis, you will pay £500 a month.
An interest only mortgage can, of course, make a mortgage seem more affordable and manageable throughout the term; however, it would mean that at the end of the term, you’d owe the lender the original capital, which in most cases would be a large sum. You, therefore, need to know from the start how you’re going to settle the lump sum to repay the loan at the end of the term. Often when applying for an interest-only mortgage, lenders will ask you to provide a stable plan that will prove you can repay everything you owe at the end.
Fixed rate mortgages
A fixed rate mortgage is a home loan which means the interest rate that you pay on your mortgage will remain the same for the duration of the entire deal period, which is typically two to five years.
If you opt for a fixed rate, you won’t need to worry about the Bank of England, or your mortgage lender, increasing their rates, making your mortgage more expensive over time. The fact that you will know exactly how much you are going to pay each month for a fixed time period helps customers feel secure and makes fixed rate products an extremely popular choice.
The downside to this is that you could end up paying more for your mortgage if the interest rates fall during your deal period. So, don’t forget, if you choose a fixed rate mortgage, there is a high chance that you will have to pay an early redemption fee if you do find a cheaper product and want to exit your deal. The best way to ensure you don’t pay too much on a fixed rate mortgage is to compare deals, so ensure you shop around first.
Standard variable rate (SVR) mortgages
A SVR mortgage is a type of interest rate which fluctuates in line with market conditions. When your initial mortgage deal comes to an end, often your lender will automatically put you on their SVR, and this rate can be whatever the lender wants it to be.
You can exit a SVR mortgage by switching to a new mortgage deal (re-mortgaging) and finding a different option to reduce the interest that you pay.
Tracker mortgages
A tracker mortgage is a home loan where the interest rate moves directly in line with another external interest rate, which is usually the Bank of England’s base rate plus a set percentage. So, if the base rate goes up, your rate on your mortgage will go up by the same amount. As this is a variable-rate type of mortgage, the total amount you pay each month could change.
Usually, tracker mortgages tend to last for two to five years, though some lenders offer trackers which last for the duration of your loan term (lifetime tracker) or until you switch to another deal.
In some cases, a base rate fall will lead to a reduction in your interest rate, however the best rates will often have a minimum rate that you pay. It’s important to remember for tracker mortgages. There may be an early redemption charge if you switch before the deal ends.
Offset mortgages
An offset mortgage is a home loan, which combines your savings bank account and your mortgage into the same statement, so any savings that you have can count as temporary overpayments towards the end of your loan. You will also have access to this account, meaning you can spend your savings if you need to.
Offset mortgages tend to have a higher interest rate as they are based on the total amount you owe, but with the right amount of savings, you can benefit from potentially rather dramatic savings.
Your home may be repossessed if you do not keep up repayments on your mortgage.