Mortgages come in all sorts of shapes and sizes. There’s lots of decisions to be made. But how do you know which mortgage type is right for you?
We have put together this brief guide to help you better understand what the options are and what they do.
Repayment methods
Early on in the mortgage process you need to decide how you will pay the mortgage back. There’s 2 options available:
INTEREST ONLY
With an interest only mortgage you are not repaying any of the money originally borrowed. Your mortgage balance will stay the same and each month your payments comprise of only the interest charged by the lender, no capital. At the end of the mortgage term you will still owe the same amount.
You need to know how the mortgage will eventually be repaid. Perhaps this could be from savings and investments, pensions or a property sale. The lender will ask this question when you apply as they need to know how you will eventually repay the debt.
REPAYMENT
Also known as capital & interest, this type of repayment option is currently the most common for new mortgages.
Each monthly mortgage payment is made up of interest and capital, calculated by the lender, so your balance will slowly reduce. If you make no changes to your mortgage and keep with all of the payments, with the very last payment your mortgage will be repaid!
At the start of the mortgage the majority of each payment will be for interest and a smaller amount for the capital repayment. As the term progresses this ratio changes and during the last years, most of the payments are capital.
Interest only mortgage vs repayment: We compare repayment methods.
PART AND PART
This is the little known third mortgage repayment method.
Here you will split your mortgage into 2 separate components. One part will be interest only and the other will be repayment.
For example:
£200,000 – Total mortgage
£150,000 – Repayment
£50,000 – Interest only
If you let the £200,000 mortgage run to the very end you will still owe £50,000. So how does this method help?
If you know that at some future point you will receive a capital sum this can be planned into your mortgage arrangements. You may have a buy to let property that you intend to sell. Perhaps an investment is due to mature in 5 years time. Or you intend to sell up and move abroad before the mortgage ends.
Choosing a part and part mortgage repayment method allows the arrangement to be more flexible and in the example above, cheaper each month as £50,000 of the mortgage is charged with the interest only.
Your mortgage broker can explain this option in more detail and help to set up your mortgage to best suit your future plans.
Interest rate options
The other major decision for your new mortgage is the type of interest rate you would like. This where the options can be a little confusing as there’s a few choices available and lenders also use different names or terminology.
Standard Variable Rate (SVR)
This is the lenders default variable rate which will vary according to external interest rates. This is the original type of interest rate and often what your mortgage reverts to once any special deals finish. It is normally higher than the other deals available.
Few borrowers should be paying this as there’s nearly always a better option.
Fixed Rate
Possibly the easiest one to understand. A fixed rate mortgage is where you pay the same (fixed) rate of interest for a fixed period of time. The interest rate is not affected by external events such as changes to the Bank of England main interest rate. At the end of the term the rate will revert to a variable rate option. This is when you need to make sure you’re not being overcharged.
Example:
3.25% fixed for 2 years (then reverts to a variable)
3.75% fixed for 5 years (then reverts to a variable)
The length of a fixed rate differs between lenders but the shortest time is usually one year and the longest 10 years or beyond.
A fixed rate gives certainty of costs, is great for cash flow planning and protects against future rises in interest rates. However, if external interest rates fall you could lose out.
This rate will have an Early Repayment Charge (ERC) should you reduce or pay off any of the fixed rate mortgage before it is due to finish.
Tracker Rate
A tracker mortgage interest rate will follow, or track, the Bank of England base lending rate plus a set margin. So it is a type of variable rate that is linked to a specific base rate and can rise and fall accordingly. It is not the same as an SVR rate (see above). A tracker mortgage deal will normally last for a set number of years before reverting to the lender’s standard rate.
Example:
Base rate plus 0.50% for 2 years
It is possible to find a lifetime tracker which as the name suggests tracks a base rate for the duration of the mortgage.
This rate will also have an Early Repayment Charge (ERC) should you reduce or pay off any of the tracker rate mortgage before it is due to finish.
Discount Rate
A discounted rate mortgage is quite similar to a tracker rate.
The deal will be a set discount from the lender’s Standard Variable Rate (SVR) for a set term.
Example:
0.25% below the SVR for 3 years
So it is a variable interest rate that will rise and fall according to the SVR.
This rate will also have an Early Repayment Charge (ERC) should you reduce or pay off any of the discount rate mortgage before it is due to finish.
Which one is right for me?
There is no right or wrong type of interest rate, the choices all depend on your circumstances and plans over the next few years.
Borrowers who need certainty of costs for a monthly budget will usually opt for a fixed rate option. This is usually a sensible option for first time buyers.
Those that feel interest rates will stay low could see flexibility with a tracker or discount rate.
End of deal options
A fixed rate or discounted tracker rate will normally last for a set period of years and then stop. What happens next will be up to you.
Do nothing
We definitely do not recommend this option!
If you choose to ignore your lenders correspondence after your interest rate ends you will be automatically put on to the lenders Standard Variable Rate (SVR) which is nearly always higher. This will be more expensive and your payments will rise accordingly.
If this does happen do not despair. You can move onto the options below but you will have paid more than you needed to in the interim.
Do something
Your current lender should contact you before your mortgage product ends but we would also advise putting a note in your diary. Start planning around 3 months before the end of your deal, this allows enough time to search for the best option and apply for it etc.
1 – Product Transfer
This is where you stay with your current mortgage lender but transfer to a new interest rate product. We have a page dedicated to product transfers which expands this topic.
2 – Remortgage
Sometimes the offer from your current lender is just not very competitive. Then it’s time to look around for remortgage deals and move your mortgage to a new lender. Remortgage lenders don’t need a deposit. Here’s how we can help with remortgaging.