Different types of mortgages explained
Like properties, mortgages come in all shapes and sizes and have different things going for them. Once you know what you’re looking for, it’s easier to find the one that’s right for you - much like buying a property.
Which mortgage is right for me?
All mortgages work in the same basic way - pay back what you borrow, plus interest.
The reason there are different mortgages on the market comes down to two main things: How interest is paid back and how interest is calculated.
Mortgages are made up of two parts:
- Capital (the money you borrow to purchase the property)
- Interest (the interest due to the lender on the amount you owe)
A repayment mortgage is where you pay back the capital and the interest together.
An interest-only mortgage is where you pay the interest monthly and repay the capital in full at the end of the term.
Different mortgages suit different people for different reasons. So let’s look at your choices:
The most common type of mortgage is a repayment mortgage.
With a repayment mortgage you pay back part of the lump sum and some of the interest every month. It’s calculated so at the end of your term, your mortgage will be paid off completely.
Repayment mortgages come in 2 different types:
Fixed Rate Mortgage
You pay back the same monthly repayments for an agreed period of time – usually 2 to 5 years. Because it’s fixed, your repayments won’t go up if interest rates rise. This provides security and can help with your budgeting but the flip side is that if interest rates go down, you don’t get the lower rate.
Before this term ends, should you not switch to an alternative deal, you will be automatically moved on to the lender's Standard Variable Rate.
Variable Rate Mortgage
Your interest rate can change from month to month – which also means your monthly repayments may change depending on what rate they are tracking. Most variable rate products either track the Bank of England base rate or the lender’s Standard Variable Rate.
So, the question is: Could I still afford payments if interest rates went up? If you’re confident you can, there’s even more choice available.
Types of Variable Rate Mortgages
Tracker mortgages such as those linked to the Bank of England will move in line with the base rate, lenders will also usually charge their own percentage on top. Some also set a minimum rate on how low your rate can drop, known as a collar rate.
While it’s unlikely that the Bank of England base rate would change each month, it could, in theory, change several times a year. You will be notified in advance of any changes.
Capped Rate Mortgage
Another example of a Tracker Rate Mortgage is a Capped Rate Mortgage, which moves in line with the interest rate it tracks but won’t go above a set amount, so you’ll always know the maximum monthly repayment you’d ever have to make.
Standard Variable Rate (SVR)
Like a tracker, your rate could go up or down. The difference is, it’s not directly linked to the Bank of England Base Rate - but by rates set by your lender. While they’re likely to base their decision around what the Bank of England rates are doing, they’re not bound by it. SVR is the rate you would usually revert to after your initial fixed or tracker rate period has ended.
This is usually a discount offered on the lender’s Standard Variable Rate and usually lasts for 2 or 3 years. It can look attractive, but the SVR itself may be high and could go up or down – so look at the rate actually offered.
Interest-only mortgages are less common than capital and repayment mortgages.
With an interest-only mortgage, your monthly payments don’t cover any of the lump sum, just the interest accruing.
This means at the end of the term the initial sum you borrowed will still need to be cleared.
If you have a £150,000 interest-only mortgage for 20 years, you’ll pay the interest on the amount you borrowed each month. When the 20 years are up, you will still have to pay the full £150,000.
If you take out an interest-only mortgage, you are also responsible for creating and maintaining a repayment plan to cover the original loan amount. Repayment plans can include; Cash saved in a savings account, shares, pension, an endowment policy or other properties or assets.
The content on this page aims to offer an informative introduction to the subject matter but does not constitute expert financial advice specific to your own situation. All facts and figures were correct at time of publication and were compiled using a range of sources.