Understanding the different types of mortgages
Last reviewed on 20 August 2017
Most of us need some financial help to buy our own homes. In this guide we look at the types of mortgages available to homebuyers.
Types of mortgages
There are two types of mortgage: repayment and interest-only. The way you repay these differs and the type you choose will depend on the cost and your attitude to risk.
- With a repayment mortgage your monthly repayments go towards paying off the interest on your loan plus some of the money you borrowed. As long as you keep up your repayments, you'll pay off your mortgage in the time agreed.
- With an interest-only mortgage your monthly repayments only cover the interest charged on your loan. You'll need to make other arrangements to pay back the capital (the amount you borrowed). Most people put money into an investment which hopefully will grow sufficiently to pay off the capital when their mortgage comes to an end. These investments include endowment policies, ISAs and pensions.
Once you've decided how you want to repay your mortgage, you can then look at the deals available.
This is where the interest rate on your mortgage is fixed for a set period of time regardless of what happens to interest rates. Fixed-rate deals typically run for two to five years but longer deals are available.
Fixed-rate mortgages tend to suit those who want to know exactly what their repayments will be each month and don't want to risk them going up.
With these types of mortgages your monthly repayments can go up and down depending on interest rates. The main types of deals are listed below.
- Standard variable rate (SVR). This is a lender's standard mortgage rate and like the Bank of England's Bank Rate it can go up and down. Lenders usually offer better rates than this on their mortgage deals, but once a deal is over this is the rate you'll revert to.
- Discount-rate. With this type of deal the interest you pay is a set amount below the lender's SVR so if interest rates change, so will your monthly repayments. Discount-rate deals last for a set period of time, typically two to five years, and then the interest rate reverts to the lender's SVR.
- Trackers. This is where the interest rate on your mortgage is linked to the Bank of England Bank Rate. So if the Bank Rate goes up so does the interest on your mortgage, but if it falls so will your mortgage repayments.
- Capped. With this type of mortgage you pay the lender's SVR but if it goes above a certain amount your repayments are 'capped' at an upper limit. When the lender's SVR falls below this level, so do your repayments.
- Cashback. This may be offered with an interest-rate deal. You receive a lump sum or a percentage of your loan in cash from the lender once you have taken out your mortgage.
- Offset mortgage. These mortgages are linked to a savings and/or current account. Any money in these accounts is used to reduce the balance of your mortgage when interest due on the loan is worked out. For example, if your mortgage is £150,000 and you have £25,000 in your savings account, you only pay interest on £125,000 (£150,000 - £25,000).
- Current account mortgage. This is similar to an offset mortgage but instead of your money being in separate pots it is usually in an all-in-one account with your borrowing acting like a big overdraft.
Many lenders now offer flexible features on their mortgages. These include allowing overpayments and underpayments, payment holidays and allowing you to make one-off lump sum capital repayments on your mortgage.