Understanding which mortgage type might be best for you
We've reviewed some of the mortgage types available, and which ones might suit you
When you’re applying for a mortgage there’s a lot to consider. That’s true whether you’re borrowing for your first home, a simple re-mortgage or a larger loan because you’re moving up to a bigger property.
It’s easy to make the mistake of simply focusing on getting a mortgage – any mortgage – that provides the right amount of borrowing, rather than choosing one that best fits your circumstances.
But choosing the right mortgage can make a big difference to your future finances. If you’re a current homeowner with significant equity in your current home, then you could find you have a much greater choice of mortgage products available to you than when you first bought. And if you’re a first-time buyer then the good news is that lenders are competing for your business.
As for buyers who have a large deposit, there is currently a range of choice when it comes to mortgages, thanks to the low Bank of England base rate.
So what types of mortgage are available, what do the different phrases mean and which one could suit your circumstances best? Here’s our quick guide.
Repayment vs interest only
Interest-only mortgages, where you pay interest on the loan without making any payment on the money borrowed, were popular a few years ago. Now though, the vast majority of people choose a repayment mortgage over an interest-only deal.
With interest-only mortgages, many people ran into difficulties because they didn’t save enough to clear the debt. Because of that, they are now harder to qualify for, and many lenders don’t offer them at all. You may want an interest-only mortgage if you’re expecting a lump sum in the future but it can be hard to secure one.
With a repayment mortgage, every month you pay back the interest on your mortgage and the loan itself, so when it ends you own the property outright.
Fixed rate vs variable interest rate
Mortgage lenders offer three standard mortgage types: fixed rate, variable rate, and tracker mortgages.
With a fixed rate mortgage, the interest you pay is fixed for a set number of years, irrespective of the market and the Bank of England base rate. They can give people the security of knowing their monthly payments won’t rise for a set period – usually between 2-5 years. Some fixed rate mortgages allow you to freeze the interest rate for as long as 10 years.
However, while a fixed rate can offer security there are some downsides. They are often slightly higher than variable rates because the lender is taking a gamble – if rates rise then the lender could be left out of pocket. Also, most fixed rates charge an early redemption fee, or early redemption penalty, should you wish to settle your mortgage during the fixed term.
That means if you want to get out of the mortgage, perhaps because rates are falling or you want to sell up, you’ll have to pay a fee that could potentially be thousands of pounds.
With a tracker mortgage, the interest rate tracks the Bank of England base rate.
A variable rate mortgage is often cheaper than a fixed rate mortgage, and less likely to have an application fee or early redemption penalty. However, because the rate is variable you are taking a risk that rates could rise and your costs would too.
Currently interest rates are low but in the past they have been as high as 15%.
Should you pay a fee?
Many mortgage providers charge a fee when you apply, often anything between £99 and £1,999. It’s important not to be put off by a fee, and instead consider the cost of the whole mortgage.
For example, a mortgage lender may charge a high fee but a low interest rate and so cost less over 5 years than a fee-free mortgage that charges a higher interest rate. You have to think long-term when considering your options.
How long should your mortgage run?
There are two things to consider when choosing a mortgage. If you’re fixing, you need to consider how long you would like to fix for. As we’ve mentioned above, that is typically 2-5 years but can be as long as 10.
However, the other question is how long your mortgage should run for. Typically this is around 25 years for a repayment mortgage, but it may be possible to arrange a repayment mortgage that runs for up to 40 years – although it can depend on your age. As a general rule, the longer the mortgage term, the lower the monthly repayments because you are not attempting to clear the debt so rapidly.
But the longer a mortgage runs, the more interest you will pay on the debt and so it can cost a lot more over time. Some borrowers will choose a long mortgage period to begin with, while money is tight, and then re-mortgage with a shorter repayment term once they can afford to do so.
One important thing to remember is that you are not tied to the lender for the full term. Once you are out of any fixed rate introductory period you are able to re-mortgage with other lenders without paying a penalty – so agreeing a longer repayment period will not affect your ability to switch to a better deal.
What’s an offset mortgage?
One less common option can be ideal for borrowers with significant savings. With an offset mortgage your savings account is linked to your mortgage debt, so the balance in your account offsets a portion of your debt.
This can mean you pay much less interest on the mortgage debt, although you won’t earn any interest on the cash. Interest paid on savings is low at the moment so many people will be better off paying less interest on their mortgage even if it means earning no interest on their savings.
The right lending for you
The right kind of mortgage for you depends on your personal preferences and circumstances. A mortgage broker will help you understand what you can afford – and more importantly, what a lender will accept you can afford.
Picking a mortgage is a personal choice but the more information you have, the more informed that choice will be. And if your mortgage application is complete and you have an agreement in principle then you can simply relax and enjoy finding the right home for you. Start your new home search today using the search bar below. We have a selection of recommended new homes mortgage advisers who can help you with your mortgage application. Ask one of our Sales Advisers for more information.