There are different types of mortgages to choose from when buying property or releasing equity. Personal circumstances and individual preferences will determine the most advantageous type of mortgage for you.
We’ve explained the most common mortgage types below. For an in-depth understanding and a personalised assessment, consult with our professional mortgage advisers.
Repayment mortgages are the most common type of mortgage used to buy a property. These mortgages usually have a fixed repayment term of up to 25 years. The homeowner will repay some of the capital they borrowed plus interest, which may be fixed or variable based on what sub-type of repayment mortgage that have.
A fixed-rate mortgage is a mortgage that comes with a fixed rate of interest for an initial period, usually a couple of years. Once the fixed-rate term is over, the mortgage typically switches to a variable rate mortgage, or the homeowner(s) may choose to remortgage for another type of agreement.
A variable rate mortgage does not have a fixed rate of interest. Instead, the interest rate payable changes over the repayment period. The lender will determine the variable rates of interest payable, but they may be influenced by an external index or benchmark.
An interest-only mortgage is a mortgage where you only make monthly interest payments on the principal amount borrowed. At the end of the mortgage term, the principal will be owed to the lender. Some people use the money they save within the repayment period to invest and hopefully make a profit before having to repay the principal. These mortgages gained popularity after the 2008 financial crash and have since been harder to secure.
There are variations of an interest-only mortgage where the principal is only repaid from the homeowner’s estate after death or if the property is sold, namely a retirement interest-only mortgage. This is an option for seniors wanting to release equity during retirement.
Buy-to-Let mortgages, also known as BTL mortgages, are mortgages used by landlords. If you plan to buy a property as a rental investment, you will need one of these mortgages rather than a residential mortgage. There are different types of BTL mortgages, and the most advantageous deal for you can be determined with professional mortgage advice.
The UK Government has recently launched a new scheme designed to help first-time property buyers get a mortgage and access a better deal using a bigger down payment.
The latest help-to-buy mortgage scheme requires first-time buyers to have just a 5% deposit, with the government providing an interest-free equity loan for the first five years to increase the down payment. With a bigger deposit, you don’t just increase your chances of getting a mortgage but also improve the potential to secure a more advantageous mortgage deal.
You must meet strict eligibility criteria, and there are valuation caps on the property you can buy using a help-to-buy mortgage. The value of the property you can buy differs by region.
An offset mortgage uses savings held in a bank account with the mortgage lender to offset the principal owed and save money on interest. For example, if you have a £200,000 mortgage with a bank and a savings account with the same bank containing £10,000, then the interest is only payable on £190,000 (mortgage balance minus savings).
Thus, your linked savings account offsets the mortgage balance to potentially help you save on interest payment only. You must still repay the principal of the loan. Sometimes these mortgages have a higher interest rate and may not be beneficial.
A tracker mortgage is similar to a variable rate mortgage because the interest rate you are subject to changes over time. However, with a tracker mortgage, the rate of interest is influenced by the Bank of England’s base rate. The rate of interest tracks the base rate plus a fixed percentage, usually around 1%.
For example, if the Bank of England’ base rate was 0.5%, the interest you pay will be this rate plus the fixed rate. If the fixed rate is 1%, then the interest payable in this example would be 1.5%. As the base rate changes over the lifetime of the mortgage, so does the interest rate you pay – for better or worse. The maximum number of times the base rate can change within one year is eight times, although it is extremely rare that the rate would fluctuate this much.
A capped rate mortgage is a mortgage with an interest rate that can change based on an index or specific reference point. However, the mortgage includes an agreement that the rate of interest will not exceed a predetermined rate for a set period of time. The capped rate is usually included for the first two years of the agreement, but not exclusively. After the capped rate period ends, the mortgage usually converts to a fixed or variable rate mortgage.
This type of mortgage comes with some reassurances in the same way a fixed mortgage provides reassurance for an initial period.
A 100% mortgage is a mortgage that does not require a down payment, meaning you buy the property by taking out a loan for 100% of its value. Most lenders require a loan to value ratio of around 80%, so these mortgages are quite rare to come by, and they present a lot of risks.
The overarching risk of a 100% mortgage is that lenders require a guarantor to secure their savings or home against the loan until a specified percentage of the loan has been repaid. They are often used by first-time buyers struggling to save, with parents acting as a guarantor by using their savings or family home as collateral.
The added risk is that the value of the property could decrease and create a situation where the buyer owes more on their mortgage than the property is worth, i.e., negative equity. Having negative equity can make remortgaging or moving home extremely difficult.
Accessing a loan to buy a property will require careful consideration and often the help of professional mortgage advisers. You’ll need to meet the lender’s eligibility criteria and have your personal finances assessed, including your income and credit score.
With limited exceptions, you’ll also need to provide a down payment of around 20%. Most lenders will only entertain applicants with a loan-to-value ratio (LTV) of 80%, meaning they will only provide a loan up to 80% of the value of the home, and you need to front the other 20%.
For personalised and professional advice navigating the many mortgage types, speak with MoneySprite mortgage advisers. We will patiently help you understand the different types of mortgages so you choose the most applicable type for your needs and preferences.
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