Types of mortgages explained – which one should I choose?

What is a mortgage?

A mortgage is essentially a loan taken out to buy a property – there are many different kinds of mortgages to choose from, but they all allow you to borrow the amount you need to buy your house, and are secured against it. This means that, if you’re unable to keep up with the payments, the lender simply takes ownership of the property to recover the funds.

What are the different types of mortgages?

There are plenty of different mortgages available on the market, but finding one isn’t always a simple process. You should choose your mortgage depending on your own financial situation, what you feel will be the right fit for you depending on your future plans, and how much you’re borrowing.

To find out more about the most commonly offered mortgages available, we’ve explained them in full below. Remember, a great mortgage for someone else may be the worst kind of mortgage for you, and depending on your financial history, not every type of mortgage may be available to you.

Repayment mortgage

With a repayment mortgage, you pay the money you borrowed to buy your home back to your lender at a steady rate, and the interest you’ve accrued. When you’re still paying your mortgage, the amount you have left to pay is called ‘capital’, which is why this type of mortgage is sometimes also called a capital or interest mortgage. Once the mortgage term ends, you’ll have paid back everything you owe in full and will owe nothing more to your lender.

Advantages:

  • You’ll own your home after your mortgage term has finished
  • You’ll make maximum profit if you choose to sell your home after you’ve paid your mortgage
  • You’ll pay less interest, as your outstanding loan amount decreases each time you make a payment
  • You’ll pay a lower interest rate than other types of mortgages

 Disadvantages:

  • Higher monthly repayments compared to other mortgages

Who is this mortgage right for?

A repayment mortgage is usually most suitable for those with good credit scores, decent savings, and higher incomes, which will allow them to keep up with larger monthly repayments.

Interest-only mortgage

You’ll only pay the interest you’ve accrued on the loan amount with an interest-only mortgage. This means you’ll have lower monthly payments to make, but you won’t actually pay back anything you’ve borrowed, only the interest you’re being charged. At the end of your mortgage term, you’ll owe the mortgage amount in full.

 Advantages:

  • Low monthly payments
  • Many people choose to invest the money they will use to pay off the mortgage at the end of the term, which may also provide an opportunity to make some extra profit

Disadvantages:

  • You’ll need to make sure you have the funds available to pay off your mortgage in full at the end of the term
  • You’ll end up paying more for your mortgage overall
  • You won’t be gaining equity of your home when you pay your monthly payments, as they don’t cover the actual loan amount

Who is this mortgage right for?

An interest-only mortgage is usually chosen by first-time buyers or those with poorer credit ratings.

Fixed rate mortgage

A fixed rate mortgage means your interest rate will be ‘fixed’ throughout the initial period you agreed to when you took out the loan. The initial period can last any number of years the lender offers, but after this, your interest rate will then change to their standard rate – which is often higher than your fixed rate.

Advantages:

  • For your initial period, you can rely on your mortgage payment remaining the same every month
  • Fixed rate is usually at a lower interest rate than the standard rate
  • You’ll be paying off your loan amount as your make monthly payments 

Disadvantages:

  • After the initial period, you’ll be moved to the standard variable rate, which is usually a higher interest rate and can increase or decrease month by month
  • If interest rates drop, your payments won’t
  • You’ll pay higher interest rates than with other variable mortgages

Who is this mortgage right for?

Many people with young families, who are looking to budget more strictly but won’t necessarily need to after the initial period ends, are attracted to the certainty and consistency of a fixed rate mortgage.

Standard variable rate (SVR) mortgage

This is a lender’s standard mortgage, with no deals, offers or added benefits. They’re free to set their own rates for their SVR, and it’s not usually a mortgage that you sign up to in the first instance, it’s more likely to be the mortgage you move onto after the initial period on a fixed rate mortgage expires. You’ll pay off what you borrowed, along with interest you accrue at the rate they set, which can change at any time.

 Advantages:

  • If interest rates drop, so will your monthly payments
  • There isn’t a usually an early repayment charge, so you’re free to pay your mortgage back in full without penalty
  • You’ll own your home at the end of your mortgage term

 Disadvantages:

  • Usually have high fees if you’d like to switch to a different mortgage or lender
  • Always are at a much higher interest rate than other mortgages

Who is this mortgage right for?

Most people don’t opt for an SVR mortgage, but fall into one after an initial deal period with a lender has finished, but there’s still capital left to pay. If you only have a small amount left to pay on your mortgage, it’s usually worth sticking out the SVR, as you can end up paying more in transfer fees to switch to another lender.

Discounted rate mortgage

Similar to a fixed rate mortgage, you’ll pay a lesser amount of interest than on an SVR with a discounted rate mortgage. However, where a fixed rate mortgage locks your interest percentage, a discounted rate mortgage will increase and decrease along with the interest changed on the SVR.

Advantages:

  • Can sometimes be the cheapest interest rate available
  • If interest drops, your mortgage payments will too
  • You’ll own your home at the end of your mortgage term

Disadvantages:

  • You might not pay the same amount every month, which can be difficult to budget around

Who is this mortgage right for?

Discount rate mortgages are a good choice for those who don’t need to worry about their payments staying the same – while you risk your payments falling or decreasing, the discount may be worth it in terms of value and savings. However, it’s difficult to budget around, so a fairly high income would be needed.

Flexible mortgage

While this kind of mortgage usually comes with a higher interest rate, there’s plenty of perks. Terms will usually allow you to pay more or less than the agreed monthly repayments to a certain degree, and can sometimes allow you to take a payment holiday for a few months. Flexible mortgages can also be combined with other types of mortgages, so there’s often a few different options to choose from.

Advantages:

  • Flexibility provides a sense of security if anything happens which affects your ability to make payments
  • You usually own your home at the end of your mortgage term

Disadvantages:

  • Usually has a higher interest rate than other mortgages

Who is this mortgage right for?

This is only usually available to people with great credit, but it’s particularly useful for people who are self-employed or whose income can fluctuate, as you can pay more or less, or take a break from payments.

Offset mortgage

An offset mortgage allows you to pay interest on your loan amount, minus any amount you have saved with the lender. For instance, if you borrowed £100,000 from a lender, but you had £12,000 in a savings account with them, you’d only pay interest on £88,000 of your mortgage loan, if you had an offset mortgage.

Advantages:

  • Saves money overall, as you only pay interest on a percentage of your mortgage
  • Encourages you to build up savings throughout your mortgage term
  • You’ll own your home at the end of your mortgage term

Disadvantages:

  • Sometimes mortgage rates can be higher than with other plans

Who is this mortgage right for?

People with a good financial history, high income and large savings amounts benefit the most from offset mortgages.

Tracker mortgage

This is a variable mortgage, which means the interest you pay can rise or drop every month. You’ll be charged an interest rate based on an official fixed economic indicator, such as the Bank of England base rate, with an added fixed amount on top – as well as the mortgage amount.

Advantages:

  • Your lender can’t hike up your interest rates for no reason
  • If interest rates drop, your monthly payments will too
  • You’ll own your home at the end of the mortgage term

Disadvantages:

  • It’s another uncertain mortgage that can be difficult to budget around, as your monthly payments can move up and down with interest rates
  • Financial crisis could see your interest rates skyrocket, as your payments are also a fixed percentage above the base rate they follow

Who is this mortgage right for?

Many people who are mortgaging their homes, and intend to pay their mortgage back in full quickly, will choose a tracker mortgage if the interest rates are low and look to stay that way for the near future.

Capped rate mortgage

A capped rate mortgage is essentially the same as a tracker mortgage, however, there’s a limit to how much the interest can rise. You’ll usually be paying a higher added fixed amount to the interest than with a tracker mortgage, but you’ll know that your mortgage can only rise to a capped amount should interest increase.

Advantages:

  • Peace of mind that your payments won’t surpass the capped amount you agreed to
  • You’ll own the home at the end of the mortgage term
  • If the interest rates drop, so will your monthly payments

Disadvantages:

  • The caps are usually above how high we’d expect the interest rates would rise
  • The added fixed amount to the interest amount is usually higher than with other mortgages

Who is this mortgage right for?

Capped rate mortgages are not usually popular with first time buyers – they appeal to the same people who consider a tracker mortgage, but also want a little more security on their monthly repayments.

Cashback mortgage

These mortgages don’t always come with usual perks of other mortgages – like free valuations or legal advice – but instead, they’ll pay you a cash amount to take out the loan. Most of the time, how much you’ll be paid depends on how much you’re borrowing, as it’ll be percentage based on your mortgage amount: but it’s usually up to £1,000.

Advantages:

  • You’ll receive a lump sum, which can be particularly useful when buying a property
  • You’ll own your home at the end of the mortgage term

Disadvantages:

  • You won’t get the perks and benefits that you usually would with other mortgages

Who is this mortgage right for?

If you’re super experienced with selling or buying homes, or you’re an accredited individual who could carry out processes such as valuations yourself, then you might find a cash lump sum more useful than the perks of another mortgage. Similarly, if you’re buying a very expensive home and the cash back sum is high enough to allow a profit margin after paying for those services, choose a cashback mortgage.

Keeping your options open

While you shouldn’t look for a mortgage in principle until you’ve found the lender you definitely want to go with, you shouldn’t initially panic about which kind of mortgage to go for. Weigh up the different kinds, and assess what you feel would be available to you, and what would benefit you most. If you’re still feeling unsure, why not speak to a mortgage broker? They’ll be able to find you a suitable mortgage, and help your through the process too

Get in touch with a member of our team for more information, or check out our other guides for more house tips.

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