Types of mortgage - Which should I pick?

Picking a mortgage might seem confusing if it's your first time borrowing. You may be unsure of the terms bandied around throughout the process.

As the saying goes, ‘knowledge is power’. With that in mind, the savvy thing to do is to learn about all of the different types of loans available to you, so that you can shop around and choose the best one for your needs. Keep reading to find out more.

What are the different types of mortgages?

In the UK, the two most popular mortgage packages are fixed-rate and trackers. But they're not the only mortgages available.

Fixed-rate mortgages

When you take out a mortgage, you pay back the full sum you’ve borrowed (the capital) and you also pay interest to the lender. Fixed-rate mortgages, as the name suggests, have an interest rate that remains the same for a specified period, regardless of bank rate fluctuations.

The advantages of a fixed-rate mortgage are:

• There is no variability in your payment amount, so you know exactly what you need to budget for every month.
• If bank interest rates rise then you won’t be affected (until your term is up).

It’s important to know both sides of the story, though.

There are cons associated with fixed-rate deals, which include:

• Fixed-rate mortgages are harder to qualify for, so you will need a good credit score.
• If interest rates drop, you’ll see no decrease in monthly payments.

In the UK, fixed-rate plans typically only last 2–5 years, at which point you switch over to an adjustable-rate mortgage plan. Alternatively, you can shop around for another fixed-rate deal and remortgage with a different provider.

Adjustable-rate mortgage options

In contrast with a fixed-rate mortgage, the interest rate on an adjustable-rate plan can change. Generally, interest rates follow the base rate determined by the Bank of England.

The benefits of adjustable-rate mortgages are:

• If interest levels go down, then so will your monthly payments as you’ll be paying less interest back. Interest rates have been low recently, due to Brexit and banking industry changes, so the interest paid on many mortgages has been low.
• Adjustable-rate mortgages are easier to qualify for than fixed-rate mortgages.

However, you should also consider the downsides and cons, which include:

• Interest rate fluctuations can affect your monthly payment — in other words, you might pay more or less from month to month. This feature can make budgeting more difficult.
• If interest rates increase, then so will your monthly payments.

Standard variable rate

One of the most common types of adjustable-rate mortgage you’ll come across is the Standard Variable Rate. This type of lending follows an interest rate set by the lender or bank, meaning they have complete control over the rate they charge you.

Just because lenders have control over the rates does not mean they will charge sky-high interest. It’s not an advantage for the lender to set a higher rate anyway, as they have to be competitive in order to gain your business.

Tracker mortgage

A tracker mortgage is another type of variable-rate mortgage which ‘tracks’ the Bank of England's base rate — meaning the interest percentage you’ll pay will go up and down in the same pattern as the base rate.

If you get a tracker mortgage, your mortgage repayments (including the interest you pay on your mortgage) could change frequently. Usually, there are added benefits to this type of mortgage, for example, most tracker mortgages will allow for a penalty-free overpayment or lump sum repayment.

Types of repayment mortgage

Repayment mortgage

The majority of homeowners have a repayment mortgage. This common plan (whether fixed-rate or variable) requires you to pay back a bit of your loan capital and the interest every month.

The pros of repaying both the capital and the interest are:

• The knowledge that you will own your home outright at the end of your mortgage.
• Repayment mortgages are easier to qualify for than interest-only plans.
• Throughout the agreed term you will have greater equity in your home than you would with an interest-only mortgage.
• It can be easier to find good mortgage deals because better rates are available to those who have higher equity in their properties.

However, with repayment mortgages, you’ll have higher monthly payments than an interest-only plan, which means you’ll have less cash in your pocket every month. To avoid problems, your lender will do thorough financial checks upfront to make sure you make your mortgage payments ok and retain enough to live on. Here are some of the main things to consider when deciding if you should pay back your mortgage early.

Interest-only mortgages

An interest-only mortgage plan requires that you pay back only the interest you owe the lender each month. You will then repay the full capital borrowed at an agreed-upon date.

With an interest-only mortgage, you’ll benefit from:

• Cheaper monthly payments, as you’re only paying off interest.
• More control over how you invest and save to make up the final lump sum.

But you also need to consider some disadvantages of interest-only repayments, such as:

• This type of mortgage is a higher risk financial product than a standard repayment mortgage. If you’re unable to raise the money you borrowed initially by your agreed date, your property will be repossessed.
• You’ll build up less equity in your home over time than you would if you had a repayment mortgage, as you’re only paying interest and not large sums of the capital you owe.
• Having less equity can make remortgaging more expensive, as better interest rates are generally reserved for homeowners with more equity in their properties.

What are the different types of specialist mortgages available?

Bad credit mortgages

If you have marks on your credit file, it can be harder to get a mortgage — but it’s not impossible. It can also make it harder to transfer or port your mortgage.

Specialist or online lenders will offer different mortgage terms (for example, different interest rates, larger deposit needed) to people who might not qualify for a mortgage with high street banks.

These types of lenders make getting a mortgage more accessible to those who’ve struggled in the past, or who’ve recovered from circumstances that left them unable to borrow from traditional banks.

Self-employed mortgages

It can be more difficult to get a mortgage as a self-employed person because you don’t have an employment contract that guarantees regular pay. As a result, your income can fluctuate from month to month. Mortgage lenders assess risks, and if your income is lower some months than others, then you may struggle to meet minimum lending requirements.

There is no such thing as a ‘self-employed’ mortgage product — you’ll apply for the same types of loans as traditionally employed people. However, the way you apply and the documentation you’ll need will differ.

Often, lenders will need to see a year's worth of financial statements or more, as well as client contracts to prove you have steady work over a certain period. They might also ask for a profit and loss statement to make sure that your income across the year is consistent and generous enough to cover repayments. If you’re self-employed, you can improve your chances of mortgage approval by having a bigger deposit to start with.

Guarantor mortgages

If this is your first step on the property ladder, or you don’t have a substantial deposit, then a guarantor mortgage might be an option for you.

A guarantor mortgage is where a parent, another relative or a trusted friend takes on some of the responsibility of the mortgage by acting as a guarantor. They will be responsible for paying the monthly instalments if you are unable, and usually, their home or savings will act as the ‘security’ or ‘collateral’ on the loan. In short, that means that if you and your guarantor fail to pay back the mortgage, the guarantor’s assets will be used to pay it instead.

Some lenders may factor in the guarantor’s collateral instead of a deposit, which means you may be able to borrow 100% of the property value: you wouldn’t be allowed to do that on a regular repayment mortgage.

Buy-to-let mortgages

Buy-to-let mortgages are for those who want to purchase properties and rent them out. You’ll be able to generate the mortgage payment and additional income with the rent you charge, making buy-to-let mortgages clever investment tools.

First-time buyer mortgages

Some lenders and banks offer first-time buyer mortgages, where you can borrow up to 95% of the home value and take that first step onto the property ladder. This type of mortgage will be most useful if you have a smaller deposit and want to borrow as much as possible to buy your first home.

Cashback mortgage deals

Some mortgage deals give you cash bonuses when you sign on the dotted line. Getting cash upfront sounds appealing, but be sure to check that the fees and interest rates don’t make the mortgage a more expensive option for you in the end.

Which type of mortgage should I get?

Interest rates are not likely to go down much further in the short term, so if you’re purchasing your first mortgage, a fixed-rate plan is probably your best option. But don’t be afraid to shop around. All mortgage providers are competing for your business, and you’re likely to find a good deal for potentially up to five years.

We recommend that most borrowers avoid interest-only mortgages. Most people don’t have enough savings or disposable income that they can confidently put aside money for 20-30 years to pay off the lump sum of borrowed capital at the end of the agreed term. However, if you’re confident with your savings account, or have investments that will support you when the time comes to pay back, then this could be a good option. You can also sell your house before the mortgage is paid off in most cases subject to the terms in your mortgage.

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