Mortgage Types Explained

Buying a property is usually the most expensive purchase any of us will make, and in order pay for it we need to take out a mortgage. But what types of mortgage are available?

When you take out a mortgage you agree to repay the capital amount (the amount required to purchase the property) and the interest (the money charged by the mortgage lender in exchange for the loan).

Repayment Mortgages

With a repayment mortgage, you agree to pay the mortgage lender a monthly sum. This amount is used in two ways; to repay some of the capital borrowed and also some of the interest on the agreed mortgage loan.

Gradually over time you will be reducing the amount you owe on the mortgage while also paying off your interest.

If you keep your repayments up to date, by the time you reach the end of the mortgage life span, you should have repaid all the money that you borrowed and all the interest accrued over the length of the loan.

However, if you decide to move house before the agreed repayment date, you cannot move your repayment mortgage with you. Instead, you will have to use the proceeds of the sale of your property to pay off your existing repayment mortgage, and agree to take out a new one on the new property.

Interest Only Mortgages

Interest only mortgages work differently. Instead of making monthly repayments that go towards repaying the capital and interest of the mortgage, you only repay the interest each month.

This means that the mortgage balance does not reduce over time, and will remain the same at the end of the mortgage’s lifespan.

You are expected to make your own arrangements to make sure that you are able to repay the outstanding amount, usually by setting up an investment plan designed to grow year after year in order to reach the required amount.

The monthly payments on interest only mortgages are lower than with a repayment mortgage, because you are not making a payment towards the capital value.

Repaying Interest

Whether you choose an interest only or repayment mortgage, you will be required to pay interest on the mortgage back to the lender. Interest charged by the lender is usually determined by calculating an amount over and above the UK’s official interest rate, set by the Bank of England.

Variable Rate Mortgages

With a variable rate mortgage, you agree to pay an interest rate that moves in line with the Bank of England’s base rate. When the base rate goes up, your monthly repayments will increase. When the base rate is reduced, you will pay less.

Mortgage-holders with variable rate mortgages know that changes to the base rate will have a direct impact on their monthly mortgage payments.

There are different types of variable rate mortgages available. A discounted mortgage will allow you to make reduced repayments over a set period before moving back to the lender’s variable rate once the discounted period expires.

Fixed Rate Mortgages

If you don’t want to spend your time worrying about interest rate movements, or you have a set budget you can afford to pay each month, then a fixed rate mortgage can give you some peace of mind, for two years, five years, or in some cases even longer.

However, fixed rate mortgages come with redemption penalties if you try to change your mortgage before the fixed rate expires. Most mortgage lenders will expect you to pay several month’s interest in exchange for leaving early.

Current Account and Offset Mortgages

With a current account mortgage or ‘offset’ plan, you can run all your day-to-day finances through your mortgage account, and in doing so, knock a few years off your mortgage’s lifespan.

By including your income, such as monthly salary and savings, you can reduce your level of interest and pay more off the capital value in a shorter timeframe.

Current account mortgages and offset mortgages are very useful as long as you have a substantial pot of savings and a high level of earnings that will help you reduce your mortgage quickly.

Flexible Mortgages

Flexible mortgages allow you to change your repayments to suit your circumstances. You can make an overpayment if you receive a bonus at work, or alternatively you can make an underpayment or even take a payment holiday if you need to.

The flexibility of this type of mortgage makes it very popular with self-employed people or contract workers with a variable income.

With so many different types of mortgage to choose from, it pays to do your research and seek professional advice from a qualified financial adviser who can help you find the right mortgage to suit your circumstances.