Mortgage Options Explained – Complete Guide

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In today’s market, there are many types of mortgage options and knowing which one is suitable for you is vital if you want to get the right deal. Even though every mortgage tends to function in a similar way, things such as repayment methods, interest rates, and fees can all be different between products. Finding the right deal isn’t simply a case of choosing the lowest rate, but more about seeking the right deal to suit your own financial circumstances.

This guide explains the different types of mortgage available in today’s market. We will look at the differences between interest-only and repayment mortgages, which are the two main types you will need to know about. And then covers the other types of mortgage products available.

Repayment mortgage

Repayment mortgage options lets you pay some of the capital amount you have borrowed, as well as some of the interest. The aim is to pay back the original loan amount plus interest over the term agreed when you took out the mortgage. This lets you build up equity over time and eventually own the home outright. Almost every mortgage product works on the basis of repayment. The only exception to this general rule is an interest-only mortgage.

Interest-only mortgage options

Interest only mortgages require you to pay the interest each month on the amount borrowed, but not any repayments towards the capital sum. Instead, the loan amount is paid back at the end of the mortgage term. If you have this kind of mortgage, you will need to ensure you have accumulated enough funds to repay the capital borrowed at the end of the mortgage period. If you don’t have the funds, you may have to sell the property to cover the sum owed. Because interest is only paid back on the whole loan, as opposed to a decreasing amount, an interest-only mortgage will cost more in the long run.

Fixed-rate mortgage options

As you might suppose, with fixed-rate mortgage options, the interest rate is fixed for a specified period and will not be affected by fluctuations in the market or Bank of England base rate rises. If you take out a fixed-rate mortgage, you will be locked into the introductory rate for a set amount of time, and if you leave before it ends, you will be subject to exit fees.

Generally, fixed-rate periods are the first two, three or five years of the term. During this time, you will know exactly how much you will pay each month, and this won’t change until the fixed term ends, arguably making it easier to budget. The certainty of fixed-rate mortgages is particularly appealing to first-time buyers who are looking to budget for the first few years, or homeowners who want to be certain of the amount they will pay each month.

A disadvantage of this type of mortgage is that once you are locked in, it can be difficult to switch because of hefty penalties that most lenders attach to their mortgage products. Additionally, you won’t be able to take advantage of any falls in interest rates during the fixed term, although you will be protected from increases in interest rates.

At the end of the fixed-rate term, you will be put onto your lender’s standard variable rate, which, in most cases, is higher. At this point, many people decide to remortgage and switch to a better deal.

Variable rate mortgage options

With variable rate mortgage options, the interest rate can shift at any time to a lower or higher amount. There is no set fixed term and so anyone on this type of mortgage is not locked in, although the amount paid each month can fluctuate. This type of mortgage product is affected by the Bank of England’s base interest rate, as well as other factors.

There is more than one type of variable rate mortgage. For each kind, the interest rate paid is calculated slightly differently.

Standard variable rate mortgage (SVR)

An SVR mortgage has an interest rate that is set by the mortgage provider and is not directly linked to the Bank of England, although in most cases, it is the principal influence as to whether it increases or decreases. A lender can either increase or decrease the rate you are paying on a monthly basis, so you may end up paying more one month, and less the next depending on the decision they make. This can make it difficult to budget. But on the flip side, an SVR can give you the freedom to overpay or leave the mortgage for another product without fear of being hit with exorbitant fees.

SVR is also the rate that lenders will transfer those coming off fixed-rate deals, which means paying a higher interest rate if they don’t remortgage.

Tracker mortgage

This type of mortgage interest rate tracks the Bank of England base interest rate, plus a few percentage points set by the lender. For example, if the base rate is 0.5%, you pay that, plus, say 2.5%, for a total payable rate of 3.0%.

When the base rate falls, the mortgage will ‘track’ it downwards, and the rate paid will be adjusted accordingly. Although the same happens when the base rate increases, so you will end up paying more each month.

Discount mortgage

Discount mortgages allow borrowers to pay a reduced version of the lender’s SVR. The amount of discount is fixed, and the reduction is applied whether the SVR is increased or decreased. Most discount mortgages only tend to be available for an introductory period, after which the borrower is switched over to the lender’s SVR. Many deals are ‘stepped’ meaning the borrower will only get access to the best discount for a set term, before being switched to a lower discount for the rest of the introductory period. Some discount mortgages are also ‘capped’ so the rate cannot either fall below or rise above a certain point.

Capped-rate mortgage

This is one of the variable rate mortgage options that will not rise or fall below a certain rate. These deals are available with either SVR or tracker mortgages. In the current market, capped rates are rare. The advantage of a capped rate is that the borrower has peace of mind that their repayments will never rise to a level they cannot afford. However, some deals have something called a ‘collar’ attached, which is another cap preventing the rate falling below a certain level. So although a borrower may be protected from a high rate, they probably won’t benefit from a low rate either.

Offset mortgage

An offset mortgage lets you link your mortgage options and savings together to reduce the amount of interest you are charged. It works by offsetting the value of a savings account against how much has been borrowed for the mortgage. This means you are only charged interest on the amount left over. Because the mortgage rate is applied to a reduced figure, the amount of interest paid each month is lower.

95% mortgage

This allows you to borrow 95% of the loan amount with just a 5% deposit. Because there is a high risk of falling into negative equity with a smaller deposit, lenders tend to charge a much higher interest rate to cover potential losses. Whilst they can be useful for those saving up for a deposit, they can make it difficult to build up equity in the property. This may be problematic switching to a better deal with a lower interest rate.

Help to buy mortgage options

This is an initiative set up by the government with the aim of helping more people become homeowners. The scheme offers three solutions: Help to Buy ISA, Help to Buy Equity Loan, and Help to Buy Shared Ownership.

Buy to let mortgage options

This mortgage is aimed at prospective landlords who want to purchase a property to rent out to others. Both interest-only and repayment deals are available, but most landlords take out interest only products because of the lower monthly payments. Rather than assessing the amount someone can borrow based on their personal income, a lender will look at the level of rent the landlord expects to receive. This is typically set at an annual rent of 125% of the mortgage payments.

 

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