Guide to mortgage types
- Guide: the different types of mortgage interest rates
- Which one is right for you is unique to your situation
- Find out which repayment type best suits your needs
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Selecting the best mortgage for you depends entirely on your personal circumstances. This includes your future plans and whether you’re buying a residential or a rental property.
There’s a huge selection of mortgage deals on the market. Finding the right one for your individual situation is often both daunting and confusing. How do you choose which suits you best?
Two main mortgage repayment conditions: fixed rate and variable rate
Mortgage repayment terms generally fall into two categories:
- fixed-rate deals, which guarantee your rate for a set number of years;
- variable rate deals, where your rate can go up or down depending on market and economic conditions.
Since the government’s disastrous mini-budget on 23 September 2022, mortgage rates have rocketed. With the future still uncertain, you can’t afford to choose unwisely.
Our guide highlights most of the different types of mortgages to help you find the one that suits you best.
What’s the initial rate period?
We’ll break out into the various types of mortgages (fixed, tracker, variable, discount, standard variable, offset, cashback, etc.) shortly. But before we address those, it’s important to understand what a mortgage’s “initial rate period” is.
First, it’s not to be confused with the “mortgage term”. That is the overall length of your mortgage.
Rather, the initial rate, also known as “initial term cost”, is the rate charged over an initial agreed period (the ‘introductory rate’ period) on your mortgage.
The rate you pay varies with each lender. Initial rates of two, three and five years are most common. But, technically, they can last anywhere between one and ten years.
Initial rate period: an example
Let’s look at an example of an initial rate period to clarify its meaning.
Imagine you select a 3.99% fixed rate mortgage deal with an “initial rate period” of two years and a “follow-on rate” of 6.99% (the lender’s “Standard Variable Rate”), over a 25-year term.
This would mean that the lender would fix your introductory rate at 3.99% for an initial period of two years.
Once the two-year initial rate period ends, you would then pay the lender’s “standard variable” interest rate of 6.99% for the remaining “mortgage term”, that being 23 years.
But there’s neither reason nor obligation to stick with that higher 6.99% at all. You can remortgage at the end of the two-year initial rate period, if it makes financial sense to do so*.
SVR (Standard Variable Rate) explained
The SVR is the rate of interest that lenders usually charged once your initial rate period ends. Each lender sets their own SVR, which is often much higher than the initial rate you’ll have paid on your tracker, fixed or discounted mortgage.
If the Bank of England raises the base rate of borrowing, lenders’ initial rates and SVRs typically follow. We’re in a cycle of raised BoE base rates as The Bank tries to get post-COVID inflation under control.
Inflation is just one reason why The Bank might want to raise the cost of borrowing; the strategy is not always successful, other than in actually raising the cost of homeowner borrowing.
Options after the initial rate period expires
At the end of your initial rate period, you can look for another mortgage deal, either:
- With your existing lender using a product switch (also known as a product transfer)
- With a new lender if they’re offering better rates and payment terms than your current lender
If you don’t remortgage at the end of your initial rate period, you will automatically switch over onto the lender’s Standard Variable Rate.
Doing nothing to avoid your lender’s SVR is the easy option, but, ultimately, more costly. Your mortgage costs could spiral, especially if global economic conditions were similar to those we’re seeing now (June, 2023).
It’s in a borrower’s best interests to look at remortgage options before they reach the end of their initial rate period. We recommend starting the remortgage process at least six months before an introductory period ends.
Repayment vs interest-only mortgages
Your monthly repayments are decided by several key factors:
- The amount you’ve borrowed
- The interest rate you’re on
- The length of your mortgage term
- Whether you’ve opted for an interest-only or a repayment (Capital & Interest) mortgage
Before you decide on the type of mortgage product you want, you need to choose between a repayment or interest-only mortgage.
Repayment (capital & interest) mortgages
Most residential borrowers opt for repayment mortgages. This means that, each month, your repayment amount comprises a portion of the outstanding mortgage balance itself, plus the interest.
With repayment mortgages, you ensure your mortgage is fully paid off at the end of the mortgage term. The mortgage term has historically been 25 years, but 30-year mortgages are gaining prominence.
If you want a shorter term, if you’ve perhaps remortgaged often and have a lot of equity, you can request 10-, 15- or 20-year terms, too.
You can even get a 50-year mortgage in the UK, now. It’s early days, but it will be interesting to see how they pan out.
The other option is the interest-only mortgage. With this type of borrowing, your monthly repayment only covers the interest charged on your mortgage for that month. By extension, the amount you borrowed to buy your home doesn’t reduce over time.
To qualify for an interest-only mortgage, you’ll need to prove to the lender that you’ve got an investment vehicle or savings plan in place to pay off the mortgage in the future. Forms of acceptable repayment plans include:
- Investment funds
- Equity in other properties you own, such as a buy-to-let
Mortgage rates: different types and how they work
Here are the most prevalent options for paying interest on lenders’ mortgages. Which is most appropriate to you will depend entirely on your circumstances, outlook and long-term plans:
Fixed rate mortgages
Fixed rate mortgages enable you to fix your mortgage interest rate for a specified period, ranging from one to ten years. For many borrowers, especially first-time buyers, this provides peace of mind. It means their mortgage payments are the same every month for that period, regardless of what interest rates in the wider market do.
With a fixed initial rate period, though, you do sacrifice a degree of flexibility. If interest rates in the market drop, you wouldn’t benefit the way borrowers on tracker or discounted rate mortgages would.
Fixed rate mortgages follow the examples we’ve already outlined most closely:
- A fixed initial rate period, between 1-10 years;
- Switch onto the lender’s (often) higher SVR after that period unless they remortgage;
- Repeat until the repayment mortgage is paid off at the end of the term.
*Nearly all fixed rate mortgages include an early repayment charge (ERC). An ERC can arise if you pay off your mortgage loan early or switch your mortgage within the fixed (initial) rate period.
The details of any ERCs will have been included in your mortgage offer when you first took out your mortgage. The net SICR figure helps determine whether product switching is viable for you.
Tracker rate mortgages
Tracker rate mortgages follow the Bank of England’s Base Rate and rise or fall with it. The interest rate your lender would charge is the Bank of England’s Base Rate plus an agreed margin. The rate you pay is therefore unaffected by changes in your lender’s SVR.
You can also opt for a ‘lifetime’ tracker, which lasts for the duration of your mortgage term. So, if you bought your home with a lifetime tracker mortgage on a 30-year term, you’d have this mortgage for the full 30 years, until you’d repaid the mortgage in full.
Many tracker rate mortgages offer flexible terms, great if you want to benefit from falling interest rates. They’re also often cheaper than fixed rates.
But, if you’re on a tight budget, a fixed rate exposes you to less risk. That’s especially pertinent in a volatile market like today’s, with rising inflation fuelled by incremental base rate rises.
Discount rate mortgages
A discount rate mortgage offers you a reduction on the lender’s Standard Variable Rate (SVR) for a set period, usually two to five years. So, the set period fixes the discount, not the rate you’ll pay.
If the lender’s SVR changes during the set period, the rate you pay will fluctuate in line with that change, but at the same, constant discount level.
Mortgages with discounted rates can attract some of the cheapest deals. But, as they are linked to the SVR, your rate will go up and down when the SVR changes.
For example, imagine your agreed discount is 0.6% below SVR. After one year, the lender’s SVR rises from 6.79% to 6.99%. Your interest rate would rise accordingly, from 6.19% to 6.39%.
If you don’t remortgage when the initial discount period ends, your interest rate reverts back to the lender’s SVR, increasing your monthly repayments. As with tracker rate mortgages, you must be certain you could afford any increases should the lender’s SVR rise.
Capped rate mortgages
A capped rate mortgage works similarly to SVRs. The rate can go up or down over time, but there’s a limit above which your interest rate cannot rise further; this upper threshold is ‘the cap’.
The cap ensures that your repayments will never exceed a certain interest rate. Plus, you still benefit when the lender’s SVR decreases. But there are no discounts from the SVR, and your monthly repayments will reflect the SVR’s fluctuations up to the cap threshold.
An offset mortgage links your mortgage to your savings. This link uses your savings to reduce the cost of your monthly mortgage payments. Instead of earning interest on your savings, you will reduce the amount of interest charged on your mortgage.
Imagine you have a mortgage of £200,000 and savings of £20,000. Your lender will subtract the £20,000 savings from the £200,000 outstanding mortgage and calculate interest only on the difference—i.e., £180,000—for that month.
Borrowers can usually choose how their offset mortgage will work for them; they can either:
- Reduce monthly mortgage repayments as a result of the reduced interest charge;
- Keep their monthly payments the same, thus reducing the overall mortgage term by paying it off at a faster rate.
Offset mortgages can have either fixed or variable rates; which you choose will depend on your repayment strategy.
The bonus with this type of mortgage is that, as you don’t earn interest on your savings, you pay no tax on them. Plus, you can withdraw amounts from your savings at any time; but, this will reduce how much your mortgage repayments are offset by those savings.
95% LTV mortgages
A 95% loan-to-value (LTV) mortgage enables borrowers to put down only a 5% deposit on the property. This means you can borrow up to 95% of the property’s value. They’re often marketed to first-time buyers, but not exclusively.
For example, if you agreed on a house sale price of £200,000, you’d only need to find £10,000 (or 5%) deposit. Thus, the mortgage of £190,000 = 95% of the £200,000 home value.
The small deposit does, however, reduce the cushion between the mortgage value and the home’s potential to fall into negative equity. This means it’s a higher risk to the lender, so they tend to apply stricter lending criteria when appraising potential buyers.
A cashback mortgage pays you a cash lump sum when you successfully complete your house purchase or make your first repayment. The cashback amounts vary most frequently between £150-£1,000, depending on the lender and the size of your mortgage.
Again, this is aimed at helping first-time buyers onto the property ladder. Borrowers can spend the money however they like, from moving costs to furniture for their new property. They’re useful for buyers who may have ploughed all their capital into fees and finding their deposit.
The initial rate period is often set between two and five years. If you move or remortgage before the initial rate period expires, you may have to repay some of that initial cashback amount.
You’ll find any ERC details in the original mortgage offer. Remember to factor in any amount you might need to repay when working out if remortgaging is the right thing for you when you near the end of the initial rate period.
Which mortgage is right for you?
Despite all this detail, you still might be unsure which is the right mortgage for you. That’s fine. Everyone has a unique set of circumstances, unique motives for buying. It’s rarely a black-and-white decision.
A brief chat with an experienced mortgage advisor will help them to both understand your situation and make an unbiased recommendation. That’s often all the clarity a buyer needs to make the right decision. Pick up the phone or request a callback to begin that vital conversation.