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Mortgages: which type do I need and why?

A mortgage is a specific type of loan used to finance a property purchase. The lender, usually a bank or building society, safeguards its financial interest by registering a charge over the property. This means that it can sell the property if the borrower defaults on the loan.

The type of mortgage you choose will depend on several factors. These might include:

-how long you want to borrow the money for;

-how much money you want to borrow;

-what level of monthly repayments you are comfortable making;

-how long you intend to live in the property you'll use the mortgage to buy;

-whether you envisage your financial circumstances changing in the future; and

-your appetite for risk.

An independent mortgage advisor can help you explore the options and assess which best suits your needs. However, here's a quick rundown on the most common types of mortgages currently offered in the UK mortgage market.

1. Standard Variable Rate (SVR) mortgages
Lenders set their own SVR rate. They also decide when to increase it. Some people may choose to take out an SVR mortgage while others may end up on one after a fixed term mortgage expires. The chief advantage of an SVR mortgage is that, unlike fixed rate and tracker mortgages, they usually do not attract early repayment charges. This can make them an appealing option for someone who anticipates repaying their mortgage early.

2. Tracker mortgages
A tracker mortgage is fixed at a point or two above the Bank of England base rate. As its name denotes, this type of mortgage "tracks" the Bank of England base rate, rising and falling in line with its fluctuations. Most lenders offer tracker mortgages for introductory periods only. After this, a borrower can expect to move onto the lender's SVR unless they have arranged a fixed rate mortgage. During times of low interest rates, tracker mortgages can be very appealing and are frequently considerably cheaper than a fixed rate product offered by the same lender.

3. Discounted rate mortgages
This is a mortgage that sets a rate that's lower than the lender's SVR. In other words, if you take out a 1% discount mortgage, you will pay 1% less than the SVR. However it's not uncommon for a discounted rate mortgage to have a so-called "collar". This means that the rate will not fall below a certain percentage.

4. Fixed rate mortgages
If you take out a fixed rate mortgage, the interest rate that applies to your repayments will be fixed for a set period of time. Periods of two, three, five and increasingly ten years are the most common. As a general rule the longer the fixed term you choose, the higher the interest rate you can expect. Offset against this is the certainty of knowing your monthly repayments down to the last penny. Even when the economy is stable, there can be good reasons to take out a fixed rate mortgage. For instance, if you're on a tight budget or are risk averse, a fixed rate mortgage is well worth considering. However, you'll want to anticipate the ending of the fixed rate term in good time as this is the point at which you'll tip onto the lender's SVR, and SVR mortgages are often higher than fixed rate ones.

5. Offset mortgages
If you have substantial savings, you may be considering an offset mortgage. This is where you deposit those savings with your mortgage lender. The savings are then offset against your mortgage repayments. Although you won't receive interest on your savings, you should make lower monthly mortgage repayments. This gives you the opportunity to repay your mortgage more quickly.

6. Repayment mortgages vs interest-only mortgages
As well as choosing a particular type of mortgage, a fixed term, tracker etc, you'll also need to consider the differences between repayment mortgages and interest-only products.

Nowadays, most mortgages are repayment mortgages, and taking out a repayment mortgage ensures that you'll be paying off the capital as well as the interest. Over time the capital element of each monthly repayment will increase while the interest portion will decrease.

With an interest-only mortgages on the other hand, you will only repay the accruing interest. This means that at the end of the mortgage term you will need to find another way to repay the capital. For some people this may mean selling the property, while others may have invested in other financial products intended to cover the initial sum that you borrowed. Although once a common financial product, the mis-selling of endowment mortgages in the 1980s resulted in thousands of people facing significant shortfalls when their policies paid out less than they had been expecting. Consequently if you're buying a home to live in yourself you're unlikely to be offered an interest-only mortgage. Buy-to-let landlords still frequently favour interest-only mortgages. Historically they have tended to rely on rising sold property prices to enable them to sell the property at the end of the mortgage term, repay the capital and pocket the profit. However this can obviously be a risky strategy in cooler markets. Falling sold property prices eating into or even cancelling out profit is the obvious risk, but even a property that takes longer than anticipated to sell can cause a financial headache for the person who needs to repay their capital loan.

Cash buyer

If you're able to finance your property purchase from existing reserves, you won't need a mortgage at all. You're also unlikely to need a mortgage if you plan to finance the purchase from the proceeds of sale of your current home. Obviously this latter situation requires selling and buying simultaneously. However if you want to buy without waiting to sell your existing property, you may want to investigate bridging loans. These are high interest, short-term borrowing products designed to bridge a funding gap. If you're contemplating one, it's vital to seek specific financial advice from an FCA-authorised professional.


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Source: 30.06.22

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