Different types of mortgages explained

If you are looking to buy a house, you should understand the importance of a mortgage and how it can help you to find your ideal home or take a step on to the property ladder. One good thing about the mortgage market is that there are so many different types of mortgages to choose from but of course, many people find having a lot of options to be bewildering. This is why it helps to have the different types of mortgage explained.

Before we talk about the different types of mortgages though, it is always worth reiterating the importance of your deposit. The larger the deposit you can offer, the more likely your mortgage application will be accepted and the better mortgage offer you should receive. This is why it makes sense to save as much money as you can when looking to buy a home and before you seriously start looking for a mortgage, you should look to put your finances in order.

You will find that although there are different types of mortgages, they all work in roughly the same way. You will borrow money to purchase a property, you pay interest on this mortgage loan and then you eventually pay off the mortgage.

Of course, there are many different mortgages and many different factors to consider. You will find that there are different lenders offering different packages, there are many interest rates, you can repay the mortgage in many ways, there are different time periods for mortgages, there are often different fees depending on the mortgage or lender and there are even specialist mortgages for certain purchases. It is easy to see why many property buyers feel overwhelmed when looking for a mortgage but when you review the options, you should find that one is more relevant to your needs than others.

Fixed rate mortgages

Fixed rate mortgages are popular mortgages because they provide a degree of certainty and consistency for a period of time. This is because a fixed rate mortgage, as the name suggests, offers a mortgage rate that is set for an agreed length of time, which could be for 2, 3, 5 or even 10 years. This means the borrower knows exactly how much money they have to pay each month, regardless of what happens with the interest rate.

If interest rates rise, people on a fixed rate mortgage benefit because they will pay less but if interest rates fall, people on a fixed rate mortgage lose out because they are paying more in comparison. Also, the starting point for a fixed rate mortgage is often higher than with a variable rate mortgage. However, the consistency of monthly payments is a great comfort to many buyers and if you don’t have much leeway with respect to what you can pay each month, a fixed rate mortgage is a smart option.

Bear in mind though that when the fixed rate period ends, the lender will move you to their standard variable rate (SVR) which is likely to see you paying more each month. If you don’t set up a new arrangement, this will happen automatically.

Variable rate mortgages

Again, the ethos of a variable rate mortgage can be understood from its title. Every lender has their own SVR and while it may be linked or influenced by the base rate set by the Bank of England, the lender has the power to change it as they see fit. If the company increases their rate, you will pay more on a monthly basis and if they reduce their rate, which they may do for commercial reasons, you will pay less money each month.

If you are optimistic about rates lowering, a variable rate mortgage can be of benefit but you need to be aware that the amount you pay each month can rise.

Interest only mortgages

Interest only mortgages are not as common as they used to be, but they are making a slight comeback in recent times. With this style of mortgage, you only pay the interest each month and then you pay off the capital element of the loan at the end of the mortgage period. This is commonly achieved by selling the property but if the property is valued or sold for less than the purchase price, the owner needs to find additional sums of money to pay off the mortgage.

The risk that selling the property isn’t sufficient to pay off the mortgage has led many lenders to withdraw this style of loan or require borrowers to have additional plans in place to pay off the loan. It is easy to why interest only mortgages are appealing, you pay less money each month and the major issue is many years in the distance, but there is a greater element of risk associated with this style of loan, which means many people would prefer to avoid it.

Tracker mortgages

A tracker mortgage, again as the name suggests, moves in line with a nominated interest rate, which is normally the base rate set by the Bank of England. In this regard, if the base rate stands at 0.25% and the tracking rate is 1.5%, the mortgage rate you have is 1.75%. If the base rate rises to 0.5%, you will end up with a mortgage rate of 2%.

Discount rate mortgages

A discount rate mortgage is one that is based on the SVR of your lender but with an additional discount on top of it. This means you pay less but of course, if the SVR rises, the amount of money that you pay each month will rise. This style of mortgage is usually provided over a fixed period of time, with the standard length of time being between 2 and 5 years.

Other mortgage types to consider include:

·       Capped rate mortgages – which means mortgage payments will never go beyond a set point, regardless of rising interest rates

·       Cashback mortgages – a mortgage that provides a percentage of the loan back to the borrower

·       Offset mortgages – a suitable mortgage for people with savings as the interest is calculated on the difference between the outstanding mortgage amount and savings that are held

·       Flexible mortgages – a mortgage that allows people to make larger payments, without penalty, if they have the means to do so, allowing them to pay off the mortgage faster and for less money

This will hopefully provide you with a starting point when it comes to understanding mortgages and if you need guidance or want to know about which mortgage is likely right for you; get in touch with Austin Property Services.