Repayment mortgages, interest-only mortgages, fixed rates, and standard variable rates… What do all these terms mean and which type of mortgage is best for you? Let’s take a closer look at the different types of mortgages and what they mean for you.
When it comes to making payments towards your mortgage, there are essentially two types – repayment mortgages and interest-only mortgages.
REPAYMENT MORTGAGES
A repayment mortgage is a type of mortgage where you pay back both the capital (the amount you borrowed) and the interest (the cost of borrowing the money) over a set period of time, usually 25 years. Your monthly repayments will consist of a combination of capital and interest, with the amount of capital repaid gradually increasing over time.
Repayment mortgages are the most common type of mortgage in the UK. They offer the advantage of being relatively simple to understand and manage, and they are also the most affordable option in the long run. However, they do have higher monthly payments than interest-only mortgages in the early years.
How Repayment Mortgages Work
Repayment mortgages work by calculating your monthly payments based on the amount of capital you have borrowed, the interest rate on your mortgage, and the length of your mortgage term. The interest rate is usually fixed for a set period of time, typically two or five years, after which it can either be fixed again or it can be allowed to vary.
Your monthly repayments will be made up of two parts:
- The capital repayment: This is the amount of money that you are paying back towards the amount you borrowed.
- The interest repayment: This is the amount of money that you are paying for the privilege of borrowing money.
The amount of capital repayment that you make each month will gradually increase over time, as the amount of interest that you owe decreases. This is because the interest is calculated on the outstanding balance of your mortgage, so as the balance decreases, the amount of interest that you owe also decreases.
INTEREST ONLY MORTGAGES
In contrast to repayment mortgages, with an interest-only mortgage, you only pay back the interest on the borrowed amount. The capital amount of your mortgage remains unchanged, so at the end of the term, you still owe the same amount. Many people have additional plans in place to repay the capital at the end of the term or make overpayments during the life of their mortgage to reduce the overall debt.
While an interest-only mortgage may have more affordable monthly repayments than a repayment option, it does not reduce the total amount owed.
If you have an interest-only mortgage, it’s a good idea to make overpayments when you can afford to (without incurring penalties) in order to decrease the loan amount.
FIXED RATE VS VARIABLE RATE
There are various options available when it comes to the interest rate you pay. The rate refers to the agreed-upon interest rate.
FIXED RATE
A fixed rate mortgage means that you have a set interest rate for 2, 3, 4 or 5 years. This guarantees that your monthly payment won’t change even if there is an increase in interest rates. It’s an excellent option if you’re concerned about rising bills and want to know exactly how much you’ll be spending each month. However, it’s important to be aware of when the fixed term ends because at that point, you’ll switch to a standard variable rate, which could result in higher payments.
You can also opt for a mortgage with a fixed interest rate for the entire term. The downside of fixed rate mortgages is that if interest rates decrease, you won’t benefit from reduced payments.
STANDARD VARIABLE RATE
A standard variable rate mortgage (SVR) is a type of variable-rate mortgage that is linked to the Bank of England base rate. The interest rate on an SVR mortgage can go up or down in line with the base rate, which means that your monthly payments could also go up or down.
SVR mortgages are usually offered as a fallback option when your fixed-rate or tracker mortgage deal comes to an end. They are also sometimes offered as an introductory rate, after which the rate will revert to the SVR.
The main advantage of an SVR mortgage is that it is usually the most flexible option, as there are no early repayment charges. However, the interest rate on an SVR mortgage can be higher than other types of mortgage, so it is important to compare different deals before you choose one.
TRACKER RATE
The interest rate charged by your lender is at their discretion and is agreed upon when you take out the loan. However, the lender can change this rate if they choose to. Typically, changes align with the Bank of England interest rates. If interest rates go up, your mortgage lender will likely follow suit and increase their rate accordingly. For example, if you’re currently paying 2.5% interest with a Bank of England rate of 0.5% and they increase rates to 0.75%, expect your lender to raise their rates by at least a quarter percent as well.
CAPPED RATE MORTGAGE
A capped rate mortgage means that although it is a standard variable rate mortgage, there is a limit or cap on the interest rate. This ensures that you won’t pay more than a certain amount even if the rate goes higher.
OTHER TYPES OF MORTGAGES
FLEXIBLE MORTGAGES
Flexible mortgages generally come with higher prices and higher interest rates, but they allow you to underpay, overpay, and take payment holidays according to your circumstances.
OFFSET MORTGAGES
An offset mortgage uses your savings to reduce the amount of interest you pay on your mortgage. For example, if you have a mortgage of £200,000 and £20,000 in savings with your lender, you’ll only pay interest on £180,000 rather than the full £200,000.
UNDERSTANDING THE DIFFERENT TYPES OF MORTGAGES
With so many different types of mortgages available, deciding what’s best for you can be challenging. It will largely depend on your circumstances, how they may change over time, and what factors are important to you. With Bank of England interest rates expected to rise and mortgage lenders increasing their rates, it might be time for a free mortgage review. Our team of experts is here to help and can offer advice on the best mortgage to suit your needs. Get in touch by emailing us or calling our team on 01934 756717.