Picking a mortgage might seem confusing. Should you choose an interest-only or a repayment mortgage? Is it better to get a fixed-rate or an adjustable rate mortgage?
The best thing you can do is read about all of the different types of plan available. Once you’re aware of what’s out there, shop for different plans via mortgage comparison websites. When you’re ready to move forward, contact a mortgage advisor for a free consultation.
Interest-only vs. Repayment Mortgages
The majority of homeowners have a repayment mortgage. A repayment mortgage plan requires you to pay back your loan and its interest every month.
- Security in knowing 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 loan period you will retain greater equity in your home than you would with an interest-only mortgage. This can make refinancing easier.
- Higher monthly payments
- Less cash in hand
An interest-only plan requires you to pay back only the interest each month. You then pay back the full initial capital borrowed at an agreed upon date.
We recommend that most borrowers avoid interest-only mortgages. This is because often homeowners don’t have enough savings to pay off the lump sum at the end. However, if you’re confident with your savings account, then this could be your best option.
- Cheaper monthly payments.
- More control over how you invest and save to make up the final lump sum.
- Inflation can cause your debt to depreciate.
- Higher risk than a repayment mortgage. If you’re unable to raise the money you borrowed initially your property can be repossessed.
- Throughout the loan period you won’t own as much of your home as you would on a repayment mortgage. This can make refinancing more expensive. Better interest rates generally become more available, the more equity you own in your home.
Fixed vs. Adjustable Rate Mortgages
Fixed rate mortgages have a steady rate of interest for the duration of the loan. In the UK, these plans typically only last 2-5 years, at which point you switch over to an adjustable rate mortgage plan.
The interest rate on an adjustable rate plan fluctuates. Generally the rate follows that determined by the Bank of England. Recent low interest rates, caused by the banking crisis and Brexit, have benefitted those with an adjustable rate by keeping the interest on their mortgages low.
Interest rates are not likely to go down much further, so if you’re purchasing your first mortgage, a fixed rate plan is probably your best option. However, shop around. All mortgage providers are competing for your business, and you’re likely to find a good deal.
Fixed Rate Mortgages
- No variability in monthly payments.
- If interest rates rise you won’t be affected.
- Fixed rate mortgages are harder to qualify for; borrowers will need a good credit score.
- If interest rates drop you’ll see no decrease in monthly payments.
Adjustable Rate Mortgages
- If interest levels decrease so will your monthly payments.
- Easier to qualify for than a fixed rate mortgage.
- More variability in monthly payments due to the fluctuation of interest rates.
- If interest rates increase, so will your monthly payments.
Types of Adjustable Rate Mortgages
Under the umbrella of adjustable rate mortgages are a variety of different plans. They all follow the principle of a variable interest rate, but each have their own unique conditions.
- A Tracker Rate is an adjustable rate plan that follows the Bank of England base rate plus a small fixed percentage.
- Most tracker mortgages will allow for an overpayment of your mortgage penalty free
Standard Variable Rate:
- A Standard Variable Rate plan follows an interest rate set by the lender. These plans are riskier than tracker rates because the lender has complete control over the interest rate they charge you.
- However, the interest rates are not completely arbitrary and do tend to follow the Bank of England base rate. Lenders have to remain competitive, so it’s not in their interest to set drastically high interest rates.
- A Discount Rate mortgage offers a reduced interest rate. Often this sort of plan is a short-term introductory rate, lasting around 2-5 years. After this time a borrower progresses onto a standard variable rate.
- Most Discount Rate plans will allow you to make overpayments with no penalty fee.
- Some of these plans will include an interest rate floor. This means your interest rate (and monthly payments) can only ever decrease to a set level, even if the Bank of England rate drops lower.
- The rarest type of mortgage. A Capped Rate Mortgage includes an interest ceiling. This means your lender cannot charge interest above a certain percentage.
- These plans are usually short-term introductory plans, lasting around 2-5 years.
- Often these plans are more expensive. You pay extra for the security of an interest rate ceiling