Which type of mortgage should you choose?

The correct choice of mortgage could easily save you thousands of pounds over the entire term.

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warning icon Warning: your home may be repossessed if you do not keep up repayments on your mortgage.
A mortgage is a loan that allows you to buy a property. The loan is secured against the property, meaning if you fall behind on repayments, the lender can repossess your home.

A mortgage is typically repaid via monthly repayments made over 25 years, although you can negotiate the term with your lender.

If you’re borrowing tens of thousands of pounds over multiple decades, you’ll pay a lot of interest on the loan. Your choice of mortgage will therefore make a BIG difference to your bank balance, so it’s worth educating yourself on the various options.

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Repayment mortgage vs interest-only mortgage

With a repayment mortgage, your monthly repayments will be based on your capital (the amount you borrowed) and the interest on your loan. With an interest-only mortgage, you only have to pay the interest, so the monthly repayments are smaller. However, you will have to pay back the capital in full at the end of the term.

Interest-only mortgages are rarer and harder to be approved for, due to the epidemic of homeowners who have previously struggled to repay their capital. In order to be approved for an interest-only mortgage, you’ll need to demonstrate a solid strategy for raising the money to pay off the capital. Lenders are more comfortable offering interest-only mortgages on a second home, because you’ll typically be able to repay the capital by selling the home.

Still, if you’re buying a home to live in, you’ll have more options and a simpler application process when choosing a repayment mortgage.

Fixed-rate mortgages

A fixed-rate mortgage gives you certainty when it comes to the size of your monthly repayments.

With these products, the interest rate on your mortgage will be fixed for a specific amount of time. The most common fixed-rate mortgages last for 2, 3, 5 or 10 years. The longer your fixed-rate period, the higher the rates tend to be. On the other hand, you will protect yourself against the possibility of interest rates rising in the future.

After your fixed rate period ends, you will be switched onto your lender’s standard variable rate. This tends to be a lot higher, which is why many homeowners choose to remortgage before this happens.

What are the pros and cons of fixed-rate mortgages?

Pros

  • You can be certain about the size of your mortgage repayments.
  • With this certainty, it is easier to budget and you won’t have to worry about interest rates rising.

Cons

  • Your mortgage repayments won’t drop if interest rates drop.
  • You’ll have to pay sizeable fees to remortgage during your fixed-rate period.

Variable-rate mortgages

This term is used to describe mortgages where the rate fluctuates. The main factor affecting the cost of most (but not all) variable-rate mortgages is the Bank of England base rate. The Bank of England will shift its base rate based on how the UK economy is performing, and with most products, your mortgage rate will shift along with it.

The three main types of variable-rate mortgages are tracker mortgages, discount mortgages and standard variable-rate mortgages.

We’ll discuss the intricacies of each of these products below.

What are the pros and cons of variable-rate mortgages?

Pros

  • Starter rates tend to be lower than fixed-rate mortgages.
  • It’s sometimes easier and cheaper to remortgage.

Cons

  • With less certainty about the size of your repayments, it becomes harder to budget.
  • If interest rates skyrocket, there’s a good chance your mortgage repayments will become unaffordable.

Tracker mortgages

Tracker mortgages are typically based on the Bank of England (BoE) base rate, although some might be based on the Libor rate.

Your interest rate will be displayed as the following: BoE base rate + X%. For example, if the Bank of England base rate is 1%, and your tracker mortgage rate is BoE + 1.75%, you’ll pay an interest rate of 2.75%.

Tracker mortgages often come with an introductory rate that lasts 2, 3, 5 or 10 years. When this introductory period ends, you’ll be moved onto the standard-variable rate, just as you would with a fixed-rate mortgage.

These mortgages can be particularly appealing when the Bank of England base rate is low, but there’s a risk that your mortgage payments will skyrocket if the base rate rises.

Some tracker mortgages are capped, but others place no limit on how high your interest rate could rise.

What are the pros and cons of tracker mortgages?

Pros

  • These mortgages can be cheap when interest rates are low.
  • Your payments will drop when the Bank of England (BoE) base rate does.

Cons

  • There’s no certainty surrounding the size of your mortgage payments.
  • Your repayments could skyrocket and become unaffordable.

Discount mortgages

Discount mortgages are usually based on your lender’s standard-variable rate. This rate tends to be based on the BoE base rate, although the lender’s own economic ambitions can affect it too.

Your interest rate will be displayed as the following: Standard variable rate – X%. For example, if the lender’s standard-variable rate is 4.75%, and your discount mortgage rate is SVR – 1%, you’ll pay an interest rate of 3.75%.

It’s common for discount mortgages to come with an introductory rate that shifts to the standard-variable rate after 2, 3, 5 or 10 years. However, there are lifetime discount mortgages available too.

What are the pros and cons of discount mortgages?

Pros

  • These mortgages can be cheap when interest rates are low.
  • Your payments will drop when the Bank of England (BoE) base rate does.

Cons

  • There’s no certainty surrounding the size of your mortgage payments.
  • Your repayments could skyrocket and become unaffordable.
  • The lender can raise its standard variable-rate whenever it wants.

Standard variable-rate mortgages

With this mortgage, you’ll pay the lender’s standard variable-rate. This is normally a lot higher than the rates offered with any type of introductory deal.

Most people on standard variable-rate mortgages are switched onto it from an introductory rate. Here are some of the reasons why people might choose to stay on this deal.

  • They want to overpay on their mortgage. (These mortgages tend to have no restrictions preventing this.)
  • They’re unable to remortgage.
  • They want to remortgage in the near future, perhaps because they’re moving house or they foresee a drop in interest rates.
  • Remortgaging is uneconomical for them, perhaps because they’ve almost paid off their mortgage.

Standard variable-rate mortgages are easier to be approved for, so it’s also possible that the applicant had a bad credit rating, and this type of mortgage was the only type that they could be approved for.

What are the pros and cons of standard variable-rate mortgages?

Pros

  • This is the easiest type of mortgage to be approved for.
  • There are usually no fees to pay if you want to switch to a different provider.

Cons

  • You’ll usually pay a higher rate compared to any other type of mortgage.
  • The lender can raise its standard variable-rate whenever it wants.

Offset mortgages

An offset mortgage considers the amount of money you have in a linked savings account when calculating your interest repayments.

You can offset your savings balance against your mortgage balance, reducing the amount of interest you have to pay.

For example, if you owe your mortgage lender £120,000, but have £50,000 in your offset savings account, you’ll only pay interest on a balance of £70,000.

This provides more flexibility than overpaying on your mortgage, while still offering a significant discount. After all, you’re able to spend or add to your savings whenever you see fit. Learn more about offset mortgages here.

What are the pros and cons of offset mortgages?

Pros

  • Reduce your mortgage interest while still having money saved for a rainy day.
  • A useful way for parents to help their children, without giving away their money.

Cons

  • Offset savings accounts don’t pay interest.
  • Interest rates tend to be higher than for standard mortgages.

First-time buyer mortgages

This is a term used to describe mortgages available with a small deposit. In fact, many lenders will consider applications from those who only have a deposit worth 5% of the property value.

There are several first-time buyer schemes that have been launched by the government to make it more affordable for first-time buyers to step onto the property ladder. Mortgages compatible with these schemes could be labelled as “first-time buyer mortgages” too.

These include Help to Buy mortgages, with which buyers can borrow up to 20% (or 40% in London) of the property’s value as an equity loan from the government.

Alternatively, shared ownership mortgages allow you to buy a percentage of the house and pay rent on the rest of it. You can then buy further portions of the home once you can afford to, using a process called “staircasing”.

What are the pros and cons of first-time buyer mortgages?

Pros

  • These mortgages allow you to become a homeowner without having to save a huge deposit.
  • It is also possible buy a house on a low income, due to schemes such as Help to Buy or shared ownership.

Cons

  • Your mortgage repayments will be higher if you have a small deposit.
  • Repaying equity loans and staircasing can be difficult for those with low incomes.

Guarantor mortgages

With a guarantor mortgage, you name an individual who would be liable for your mortgage debt if you fall behind on your repayments.

This extra security against mortgage arrears helps lenders feel comfortable to approve applicants they might have otherwise rejected.

Most applicants choose a family member to be their guarantor, although it is possible to choose anyone. Your guarantor will undergo financial checks, so that the lender can see they have the funds available to cover the homeowner.

What are the pros and cons of guarantor mortgages?

Pros

  • This simple step makes it easier to be approved for a mortgage.
  • It’ll make no difference to anyone’s finances, provided you don’t fall behind on repayments.

Cons

  • Your guarantor will have to fill out paperwork and go through financial checks.
  • If your guarantor is forced to fork out money, it could ruin your relationship with them.

Joint mortgages

You can apply for a mortgage jointly with up to three other people.

When you do this, your income and credit score will be considered jointly. It should be easier to save up a large deposit too. This is great news if you have a poor income and credit score. However, if a co-buyer has a bad credit score, it could actually harm your chances of being approved for a mortgage.

There are two types of joint mortgage:

  • Joint tenants. All homeowners jointly own 100% of the property. If one dies, their share is automatically passed on to the co-owners. This option is usually chosen by married couples.
  • Tenants in common. All homeowners own an individual share of the property. You can arrange for the portions to be divided unequally, if necessary. If one dies, they can leave their share to someone else in their will. This option is usually chosen by friends or relatives who are buying together.

You’ll be jointly responsible for repaying the entire mortgage. That means if one co-buyer stops contributing towards the mortgage, you’ll still be equally liable for the debt. You’ll also have to agree on when the house should be sold.

What are the pros and cons of joint mortgages?

Pros

  • Home ownership becomes more affordable.
  • Your low income or poor credit becomes less of a red flag to lenders.

Cons

  • If your co-buyer has a poor credit history, it could harm your chances of being approved for a mortgage.
  • You may end up responsible for your co-buyer’s arrears.
  • Co-buyers have to agree on when to sell the property.

Features to look out for

  • Fees. When arranging a mortgage, you’ll usually be expected to pay a number of one-off fees. These often have different names including arrangement fees, processing fees or administration fees. You’ll also pay a valuation fee. The size of these fees can differ massively, so consider these as well as the interest rate you’re paying.
  • Portability. You may or may not be allowed to port your mortgage when you move house. If your mortgage isn’t portable, you’ll have to remortgage before you move. This can be expensive and there’s no guarantee you’ll be approved for an equally good deal.
  • Repayment holidays. Some mortgages will allow you to take a break on repaying your debt for up to a year. This could be useful if your financial situation worsens, although interest will continue to accrue on your debt.
  • Mortgage overpayments. A selection of mortgages will allow you to overpay, so that your debt can be cleared quicker. However, some mortgages won’t allow overpayments, others will place a limit on how much you can overpay, while others will charge a huge fee if you do so. If you’re keen to overpay on your mortgage, look out for deals that allow this.

Cashback mortgages

With these mortgages, the lender will transfer a cash bonus into your account once the mortgage has completed. In the past, lenders have offered cashback of up to £1,500. This incentive is increasingly being used in an effort to stand out from competitors, but it often only serves as a mask to cover inferior mortgage rates.

Instead of being swayed by cashback, calculate the total cost of your mortgage during the introductory period, including all cashback, one-off fees and your monthly repayments.

Learn more about cashback mortgages.

Daily calculation or annual calculation of interest?

Daily interest calculation will always work out cheaper than annual interest calculation.

This is because the latter doesn’t take into account all the repayments you’ve made on your debt as soon as you make them. Instead, you’ll be charged interest on the same higher balance over the course of a year.

Mortgages with annual interest calculation are rarely offered these days. If you’re paying this way, it’s likely you’ve been doing so for a while. Call your lender and ask if it’s possible to change. If you can’t, it may work out cheaper for you to switch to another mortgage provider, even when you account for remortgaging costs.

Bank or building society?

It’s often recommended for home buyers to investigate mortgage offers from building societies instead of banks.

Previous research has suggested that building societies tend to offer better rates, and they’ve been praised for being more lenient during the application process.

It’s common for them to hold exclusive offers for those buying a house within their branch operating area.

However, it’s not a given that a building society will offer the best deal. You should search the whole market to find the best mortgage deal for you.

What length of deal?

It’s possible to stay on a standard variable-rate for the entirety of your mortgage term, but you’ll save a lot of money by remortgaging to different introductory deals until your mortgage is paid off.

These introductory deals typically last either 2, 3, 5 or 10 years.

The main benefit of a shorter deal is that these tend to have lower rates. The main advantage of longer deals is that you’ll be protected against the possibility of interest rates rising for longer. You’ll also have to remortgage less often, saving you from the hassle and the fees involved. Also, there’s no guarantee that you’ll be approved for a remortgage in the future if your financial circumstances change.

It is impossible to accurately predict what will happen to interest rates in the future, so the best length of your mortgage deal will mostly be based on your attitude to risk.

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