Choosing the right option when taking out a mortgage deal is one of the biggest financial and life-changing decisions you can make. That is why when making that decision you as a first-time buyer should look at the four main types of mortgages to help potential home buyers make the right choice when looking at mortgage offers. The first step is to ensure that the mortgage lender you decide to choose is authorised and regulated by the financial conduct authority.
Interest Only Mortgage
An interest only mortgage is where the borrower only pays the cost of the interest. This type of mortgage lasts for a fixed period of time which is typically between 5 and 7 years, after which time the borrower will begin to off the entirety of the loan.
There is an advantage to this - the monthly repayments are kept low at first meaning that the borrower's money can be invested in other areas during this time period. However, this type of mortgage lends itself to the home buyer being able to afford the repayments once the interest only period has come to an end.
Fixed Rate Mortgage
Fixed rate mortgages are when there is an agreement between the borrower and the mortgage lender that there will be a fixed interest rate for a certain time period at the start of the loan. This can be between 1 and 10 years. The advantage of choosing this type of mortgage is that the home buyer knows exactly how much they will be paying every month regardless of what happens with interest rates outside of their mortgage. However, if the interest rates drop, the buyer will end up paying more than they would if they had chosen another type of mortgage. This also means that there are high fines if they wanted to get out of the mortgage early.
Variable Rate Mortgage
A variable rate mortgage is what it says - variable. This means that your mortgage rate will fluctuate depending on variables such as the UK economy. Interest rates are normally cut when the economy is suffering and increases when the economy is strong.
Variable rate mortgages have three categories:
The interest rate moves in line with one particular economic indicator. Usually, these mortgage payments work on a Base Rate +% basis - if the base rate that your mortgage is tracking goes up, your payments also increase. However, if the base rate drops, so will your payments.
Standard Variable Rate Mortgages
A standard variable rate mortgage is where the mortgage has a variable interest rate that vaguely follows the Bank of England’s movements. In most cases borrowers who start on an interest-only or fixed-rate mortgage will end up on a standard variable rate mortgage once their initial fixed period has ended.
Discount Rate Mortgages
This mortgage is where the home buyer is offered a discount on the standard variable rate. Despite discounts usually only lasting for a few years, there are exceptions to this. It is wise to ensure you have all the information you need about this type of mortgage, as terms can be unclear, and you may end up paying a lot more once the initial discount period has ended.
A repayment mortgage is when the borrower pays both the interest and the cost of the home together in instalments over a fixed period which is commonly 25 years. This means that once the fixed period is over the borrower will have paid off both the house and the accrued interest.
Generally, your first few years of payments will have high interest, but the amount of capital you pay off will go up in bands throughout the fixed period.
There are other costs that can be incurred through the likes of stamp duty and legal fees from a solicitor, which is something that you need to take into consideration when taking out a mortgage.
Once you have an idea of the type of mortgage that would work well for you, speak to a mortgage adviser about your options such as amount and monthly payments. Brokers will be able to give you any extra information you need and advise you on the best deals available. It may be that there is an option to combine mortgage types in a way that suits you. However, bear in mind that some lenders don’t offer their mortgages through brokers, so it is advised to do some of your own research as well including using online mortgage calculators.