Thinking of buying a property and wondering about the different types of mortgages on offer? Should you go with a fixed-rate mortgage loan or would you be better off with a variable rate deal? We look at the various types of mortgages available.
Navigating the different types of mortgage loans can be a bit confusing. There’s various types of loans on offer, and it’s difficult to know which way to turn if you’re not familiar with them. Is there a particular type of mortgage that would save you money or best suit your needs? In a nutshell, unless you’re a later life borrower (in which case you may be looking at a retirement interest only mortgage), there are several types of mortgages. These include the following:
- A fixed rate mortgage
- A variable rate mortgage
- A tracker mortgage
- An interest-only mortgage
What is a fixed rate mortgage?
A fixed-rate mortgage is often a popular choice for many buyers. According to the Moneyfacts website, there are more fixed-rate mortgages available than other types of mortgage loans. In November 2020, 86 per cent of mortgages shown on the comparison website were fixed-rate deals. A fixed-rate mortgage simply means that the interest rate on your mortgage loan is fixed for a specified term, normally between two to five years. This means your monthly mortgage payments will stay the same. A fixed-rate mortgage can offer peace of mind as you know you’ll be paying exactly the same amount each month and can budget accordingly.
You can typically fix the term for two to five years. However, there are some five to ten year fixed rate deals but the longer the term, the higher the interest rate. Fixed-rate deals can often have a slightly higher interest rate than variable-rate mortgages. Remember that with a fixed-rate term, if interest rates fall, you will still pay the same amount every month.
Why have a fixed rate mortgage?
With a fixed rate mortgage, you are tied in to the mortgage for the specified term. If you want to exit the mortgage term early, for instance if you split with your partner and want to sell your property, you’ll face an early repayment charge.
At the end of the term, your lender will usually place you on its standard variable rate which is likely to be higher than your existing rate. Before this happens, you’ll want to look at switching to a new mortgage loan to get the best possible deal. Allow at least three months for your broker to look into finding you a competitive new loan.
What is a variable rate mortgage?
A variable rate mortgage means your interest rate fluctuates, either in line with the Bank of England Base Rate or at the discretion of the lender. It can therefore mean you will pay less interest if rates go down and more if they go up. You will benefit from any saving but can’t be sure you won’t face an increase in your monthly repayments at some stage.
Why have a variable rate mortgage?
Although variable-rate mortgages are considered more flexible, there aren’t many benefits to having one at the moment with borrowing being so cheap. You may be better off having a fixed-rate mortgage loan and knowing that your monthly payments will stay the same.
What is a tracker rate mortgage?
A tracker rate mortgage is a type of variable rate mortgage where the interest rate moves with the Bank of England’s Base Rate. This means your repayments could change regularly. Again, you could benefit from a possible saving on your payments if the rate comes down or you could pay more if it goes up. The typical term of a tracker mortgage is two to five years. At present, the Bank of England’s base rate is at a historic low of 0.1 per cent.
Why have a tracker rate mortgage?
As with a variable rate mortgage, a tracker rate mortgage may offer a lower rate than other deals. Variable rates tend to be lower, so it might mean you could afford to make overpayments on your mortgage.
What is an interest-only mortgage?
An interest-only mortgage is where you only pay the interest on the mortgage every month and not the loan. The amount of the loan will stay the same (unless you choose to make overpayments). Usually, with an interest-only mortgage, you’ll be asked to show from the start how you will repay the loan at the end of the mortgage term. Your lender will need to see a clear plan showing you’ll have enough money to repay it when the time comes. It’s crucial to ensure you have a strategy for repaying the loan in future, such as selling your property and downsizing or using stocks, shares or investment bonds to clear the balance.
Why have an interest-only mortgage?
The monthly payments will be considerably lower than if you took out a repayment mortgage where you’d be paying off a combination of some of the capital and some of the interest.
You might have an interest-only mortgage to make your monthly payments lower and to give you more financial freedom. You might want to save up enough money to buy another property or make another significant purchase.
If you plan to use an investment to repay an interest-only mortgage, bear in mind the degree of risk as investments can change. Similarly, if you’re hoping that house prices will rise, they may not increase sufficiently to repay your mortgage. Interest-only mortgages are not a good choice for most borrowers. We would only recommend getting one if you are extremely confident that you have a sound repayment plan at the end of the loan, or if you are intent on selling the property to downsize. Even then, it’s important to be aware of the risks and do your calculations cautiously.
More information
When deciding what type of mortgage is best for you, it’s worth thinking about what your long-term strategy is so that you can get the right deal for your personal situation. We’re here to help with advice.