Unless you are a cash buyer, finding the right property is only half of the job. You will also have to acquire a mortgage best suited to you. This will be determined by, amongst other factors, your overall circumstances, future plans, past, present, and future financial situation.
However, before working out and deciding between different mortgages, you have to decide what type of mortgage you should get. To make matters worse, there are numerous types of mortgages, and it can be mind-boggling for many to choose between all the options.
This article, which is part of a series of articles on residential conveyancing process, will take you through the main types of mortgages and leave you with some pro tips on choosing what mortgage type is best for you.
What are the main types of mortgages?
A mortgage is long term commitment. If you pick the wrong type of mortgage and later on cannot afford it, you risk being repossessed by your lender.
Therefore, it would be a wise idea to familiarise yourself with the different types of mortgages you will come across.
A fixed rate mortgage means that the interest you will pay will remain the same until an agreed date, regardless of interest rates changes in the market.
1.1.What happens after the fixed rate period ends?
However, the interest rates will revert to the mortgage lender’s standard variable rate after the agreed date.
Most common fixed rate mortgages have either a 2 or 5 year fixed rate period. Although, there is an increasing number of 10 year fixed rate mortgage deals available as well.
1.2.What are the major benefits of fixed rate mortgage?
Since the interest rate will remain constant throughout the agreed period, you will know precisely what your mortgage repayments will be. If you are on a tight budget, you can plan it accordingly, so you don’t end up getting drowned in repayments.
Generally, fixed rate mortgages come with higher interest rates as compared to their counterparts. However, you have to decide whether this is a smaller price to pay for the security of fixed interest rates.
1.3.Which fixed rate mortgage is best for you?
A longer fixed rate mortgage will give you greater certainty about what your repayments will look like.
However, even if you are currently financially stable, it does not mean that your circumstances cannot change maybe 4 years down the road. If they decline, you may not be able to afford the mortgage at all. On the contrary, if your circumstances improve and you may be able to afford to pay off the loan a lot faster. However, you will have to pay an early repayment charge if you do not want to be tied down for the original duration of the loan.
So you have to balance the need for security of fixed interest rate over a long period against being stuck with the responsibility of making mortgage repayments over a prolonged period.
Interest rates in tracker mortgages follow the base rate of the Bank of England by a set amount for either the entire length or a specified period (after which the interest rates revert to the lenders’ standard variable rate).
2.1.What are the main benefits of a tracker mortgage?
A tracker mortgage can often present the best value option. It is also the most transparent mortgage type. You will be aware at all times what your interest repayments as your lender will be by following the Bank of England base rate.
2.2.A double edged sword
If the Bank of England base interest rates fall, so will your mortgage payments. However, tracker mortgages are like a double edged sword. Sudden or major fluctuations in the base rate can disastrously impact your repayment levels. Due to this reason, tracker mortgages can be unpredictable.
Further, mortgage lenders often equip these deals with what is known as a “collar” to stop your repayments from going too low (usually when the Bank of England base rate drops below a certain percentage).
If you are on a tight budget, you are better off on a fixed term mortgage.
In a standard variable rate mortgage (SVR mortgage), your mortgage lender has the freedom to vary interest rates and charge however much they want. So it is best to completely avoid them.
Usually, people end on variable rate mortgages because their fixed term or tracker period has expired. If you are on a standard variable rate mortgage, you may be able to save some money by remortgaging.
To learn more about what is remortgage and how does remortgaging work, check out our article on this subject.
Discounted mortgages are often offered by lenders who want to attract customers to their more expensive standard variable rate mortgage by provisionally reducing their standard variable rates by a certain amount.
Once the discounted rates period ends, you will end up on their standard variable rate mortgage. So you need to consider whether you are better off on a fixed rate mortgage.
For discounted mortgages, it is important to know and understand the circumstances in which you can remortgage (if at all).
Although not the most popular mortgage type, offset mortgages can be a suitable choice if you have a decent pot of savings.
5.1.How do offset mortgages work?
In an offset mortgage, the lender will consider how much savings you have. You will only be charged interest on the difference between your savings and the amount you are being lent, resulting in lower repayments.
5.2.Can you dip into the saving offsetting your mortgage?
However, while you can still access those savings, your mortgage repayments will go up accordingly. Further, if you are using savings to offset your mortgage, you won’t earn any interest on that amount.
Hence, for this reason, offset mortgages are more popular amongst those already in higher tax bands. Read our article to find out more information about what is an offset mortgage.
As the name suggested, first time buyer mortgages are special deals for first time buyers.
6.1.How do first time buyer mortgages help people climb the property ladder?
First time buyer mortgages usually offer lower deposits requirement that go as low as 5%. That means that you could borrow up to 95% of the property’s value. Further, first time mortgages generally have lower application fees.
Often these mortgages are tied in with government schemes such as Help to Buy.
In a guarantor mortgage, another individual (usually a parent or a close relative) acts as a guarantor and make the repayments if you default.
7.1.How does a guarantor mortgage work?
The process usually involves the guarantor putting up their home or savings as security. Due to this, the lendee can borrow larger sums (even up to 100% of the property value) compared to other mortgages.
8.Buy to let mortgage
Buy to let is where you purchase a property to further rent it out to generate extra income.
8.1.How buy to let mortgages work
Standard residential mortgages do not normally allow the borrower to let the property after it has been purchased. Further, the factors involved in how much you can borrow will be different than if you planned to live on the property.
As you plan to rent it out, your mortgage lender will want to see how much rent will be generated. Generally, mortgage lenders expect the rental income to be 25% more than the cost of the mortgage.
You may wish to read our article on what is buy to let mortgage for further information.
An interest only mortgage allows you to first repay the interest (fixed or variable) on what you have borrowed without making any repayments towards the principal amount.
At the end of the term, you pay back the principal amount in one lump sum payment.
9.1.Who can qualify for an interest only mortgage?
This type of mortgage can be applied by anyone. They are also usually available for people purchasing a property for buy to let.
However, you need to figure out how you will pay the principal amount as, before you can get accepted for one in the first place, you will have to show your mortgage lender how you plan to pay the principal amount at the end of the mortgage.
So you will need either of the following:
- Savings account – While you repay the interest, you could save for repaying the principal in an ISA or other types of savings accounts. Read our article to learn more about what is a lifetime ISA.
- Financial instruments – You can build up savings through long term investment in shares or stocks.
- Real property and other assets – If you own a property, perhaps you have inherited one, you could sell it off and repay the principal amount.
- Pension schemes – you could show that you can repay the principal amount by withdrawing from one or more pension accounts.
In contrast to interest only mortgages, in repayment mortgage (formally called "capital repayment mortgage") you repay the principal amount along with a portion of interest each month, over a long period which can be anywhere up to 40 years (but usually it is between 20 to 30 years).
Repayment mortgages are also one of the most popular choices amongst people who want to live in the property, rather than further renting it out ( which is called “Buy to Let”).
10.1.How do repayment mortgages work?
While in the first few years, a large chunk of your monthly mortgage payments will go towards paying off the interest, whereas a smaller portion will go towards paying off the principal amount. So initially, you may feel like you haven’t even made a dent in the amount you owe.
However, in repayment mortgages, with time, the balance shifts. As long as you continue to make your monthly repayments, your repayments will go more towards paying off the principal amount and less towards interest payment.
Another important point to consider, depending on the term of your mortgage, is that if the repayment period is too long (for example, 40 years), you may want to move before that time is up. You may be able to port your mortgage. Otherwise, you can pay off the mortgage and seek a better mortgage deal for your new property.
Read our article to learn more about porting a mortgage.
10.2.What is the interest in repayment mortgages?
There are several types of repayment mortgages. For instance, it can be a:
- fixed rate mortgage
- tracker mortgage
- discounted mortgage
- standard variable mortgage
- offset mortgage; or
- guarantor mortgage
The bottom line
There are thousands of deals available in the mortgages market for borrowers.
The above-listed mortgages are the main types of mortgage. We hope that summarising how each of these works helps you decide which type of mortgage is best for you.
However, along with the types of mortgages, you also need to familiarise yourself with how interest is calculated on mortgages and how it affects your repayments.
It is one of the main sources of confusion for borrowers that lenders unfairly rely on to add thousands of pounds to the mortgage cost.
The amount of interest you have to pay on the principal amount can either be calculated:
- monthly; or
You are best off going for daily calculation and completely avoiding mortgages with annual calculation.
The reason is that with annual interest calculation, the mortgage lender will calculate the interest rate for the entire year only once. In this situation, you risk being charged on debts you have already paid back.
Consider the following example:
If your interest rate is calculated on 1st January and you pay 6000 pounds on 2nd January, you will still be charged interest as if you had never made that payment. As there is nothing illegal about this (although immoral), such mortgages are best avoided.
Now that you are equipped with the necessary information on types of mortgages and how each of them works, you are ready to go into the market and explore the best mortgage option for yourself.
In the end, we will leave you with some pro tips on finding the best mortgage for you.
Don’t expect help from others
You should not expect any help from your solicitor or licensed conveyancer, or estate agent in deciding which mortgage type is best suited to you. However, you can hire a mortgage broker.
These are professionals who are familiar with most of the mortgage products and deals available in the market. Further, they can advise you on which type of mortgage you should get based on your financial situation. However, you should read our article on what is a mortgage broker and the pros and cons of hiring one before you approach any mortgage broker.
Always do your own research
Always conduct your own search of the mortgage market for mortgage deals to ensure that you aren’t missing on any. Some mortgage lenders do not work with any mortgage broker.
Thoroughly plan out if you are self-employed
If you are self-employed, unless you thoroughly plan it out, you will find it quite difficult to get a mortgage offer. You may wish to read our self employed mortgage guide for further information.
Look into the government home ownership schemes
It would also be a wise idea, particularly if you are self-employed, you are self-employed, to look into the government schemes available to help people climb up the property ladder. There are more than one ways of buying a new home. Read about affordable homeownership government schemes in our article to get more information.
Mortgages for those with bad credit
Though it may be more difficult, it certainly is not impossible to find a mortgage if you have low credit.
Some lenders have products specifically designed for people who have been rejected a mortgage or have a poor credit history. You can also take some very simple steps to improve your credit rating.
To find out more information and what those simple steps are, read our article on mortgages for bad credit.