Understanding the different types of mortgages
Selecting a mortgage is a big decision, and you’ll want to think about it carefully. While you can choose a mortgage yourself, most people choose to get advice from either a mortgage broker, or directly from a lender when buying a home. But it’s good to know what the different types of mortgages are, so you can feel fully prepared for a conversation.
Fixed-rate mortgages guarantee your interest rate for a set period of time. Your monthly payments remain the same for a specified period, and won’t change until an agreed date. This can be anything from two to five years, up to 10 years, and sometimes even longer.
The majority of mortgage holders have a fixed rate deal. Around 95% of all new loans were on a fixed rate in 2022, and 85% of all people with a mortgage are currently on a fixed rate.
Pros of a fixed-rate mortgage
Fixed mortgages are great for the certainty and peace of mind that comes with knowing exactly what you have to pay each month during the fixed period, regardless of what happens to interest rates.
Paying a set amount each month also means that you’ll know what your mortgage balance will be at the end of fixed rate deal. It’s helpful to know this because the amount you owe at the end of the mortgage deal will have a big impact on your loan to value (LTV), which is expressed as a percentage, and it reflects the size of the mortgage you need as a proportion of the value of the home you want to buy. This will also impact the cost of your next deal. This is something you could ask your lender or broker to explain, and to show you.
Cons of a fixed-rate mortgage
The interest rates may be higher on a fixed-rate deal than for other mortgage types. Also, if the Bank of England Base Rate falls during the fixed period, your monthly payments won’t drop, as they would with a tracker mortgage.
When the fixed period ends, it’s most likely that you’ll be transferred onto the lender’s Standard Variable Rate automatically, and this will usually have a higher rate of interest than the fixed deal you were on previously. But, as your deal will have ended, you’ll be free to move onto a new mortgage, so it’s a good idea to plan ahead well before your fixed period ends.
Because you’re on a fixed rate, lenders have to lock in this funding for the duration of the term. So, if you repay your loan in full, or make significant overpayments – usually more than 10% of your balance – you’ll pay an Early Repayment Charge.
Early Repayment Charges (ERC) are usually a percentage of your outstanding balance and reduce with time. For instance, if you have a 5-year fixed-rate deal, the ERC will typically be about 5% in first year of your deal, falling to about 1% in the final year.
Pretty much all lenders enable you to move home without needing to pay an ERC during a fixed-rate deal – this is known as porting a mortgage. And any additional money you borrow will be on a new rate. So, if you stay with your existing lender, there won’t be an ERC when you move.
A tracker mortgage has an interest rate that’s usually linked to the Bank of England’s (BoE) Base Rate, plus a percentage amount set by the lender. That means the mortgage interest rate can vary throughout the tracker period, depending on movements in the Base Rate (the official interest rate that the Bank of England charges banks for lending them money – something that it reviews on a regular basis).
So, if your mortgage is set at 1% above the Bank of England Base Rate, and the BoE rate goes up or down by 0.5%, your tracker rate will move by the same amount. For example, if you have a mortgage of £150,000 with a term of 25 years and a rate of 2.5%, you will currently pay £673 a month. If the Base Rate goes up by 0.5%, you will now have an interest rate of 3%, and pay £712 a month. However, if Base Rate is reduced by 0.5%, you will now have an interest rate of 2%, and pay £636 a month.
Trackers are typically for 2 years, but can be for the term of the mortgage. After your tracker term has finished, you will automatically move on to the lender’s Standard Variable Rate.
Pros of a tracker mortgage
Lenders can’t influence what your mortgage rate will be during the tracker period. Because your mortgage is usually linked to the BoE Base Rate, it will follow that rate, plus the lender’s percentage.
Unlike with fixed-rate mortgages, trackers don’t usually come with Early Repayment Charges (ERC), so you can overpay unlimited amounts without being charged. This can be good if you have variable income, or are expecting large lump sums that you want to put towards your mortgage, such as an inheritance.
It also means you’re able to move to another rate at any time without incurring an ERC. This means that you could move to fixed rate with your existing lender, or you could remortgage with another lender.
Should you move house when you have a tracker product, you can still ‘port’ it, but any new borrowing you take will be on a new rate. Unlike with fixed-rate products, if you move home, you won’t be charged an ERC if you choose to take a mortgage with another lender.
Cons of a tracker mortgage
Your mortgage payments can change at any time. If the Base Rate rises, your payments will go up. Similarly, if they go down, so will your interest rate. This means you don’t have the certainty that you would with a fixed-rate mortgage.
Therefore, you’ll need to ensure that you’re able to afford increased payments, and that you can manage changing payments each month. It may seem obvious, but the bigger your mortgage, the more you’ll have to pay should your tracker rate increase.
Your lender must get in touch with you whenever your tracker rate changes, to let you know what your new payments will be. They need to inform you before your next payment is due, and give you reasonable notice.
Having a variable monthly payment also means that you’ll have less certainty about what your mortgage balance will be when your tracker rate ends.
Knowing what your balance will be is helpful, because the amount you owe at the end of the mortgage deal will have a big impact on your loan to value, and as a result, the cost of your next deal.
Standard Variable Rate mortgages (SVR)
An SVR mortgage has an interest rate that’s set by your lender, and it’s usually the rate you would automatically move onto at the end of your fixed or tracker product. As SVRs are variable, and not directly linked to Base Rate, the lender has more discretion about the rate and when it changes.
In reality, most lenders will only change their SVR rates in response to a Base Rate change, but the exact amount of change will vary based on the individual lender’s circumstances. And sometimes, lenders won’t change their SVRs in response to a BoE Base Rate change.
Lenders have to notify impacted customers of changes to their SVR in two ways. Firstly, the lender will get in contact with all customers that are paying the SVR directly, to give them a personalised view of the impacts – specifically, what their new monthly payment will be.
Secondly, for customers who are still paying their fixed or tracker rate, the lender will publish its SVR – usually on its website – so that they are aware of the rate, and can budget for it accordingly.
In many ways, the pros and cons of SVRs are similar to trackers. You can make unlimited overpayments, move to a different product, move to another lender, or completely repay your mortgage, without paying an Early Repayment Charge.
The cons are similar as well, but with one big difference: SVRs tend to have higher rates than a lender’s fixed or tracker products, and they are therefore not very attractive to many borrowers. The vast majority choose to get another fixed or tracker rate, either with their existing lender (often known as retention products or switching), or by moving to a new lender (often known as remortgaging).
Lenders will usually get in touch with you 3-6 months before the end of your deal to outline your options. If you got your mortgage through a broker, it’s likely they’ll be in touch around this time to discuss your options, including staying with your existing lender, as well as moving to another lender, too.
If you stay with your existing lender, you may be able to move to a new deal up to 6 months early, without paying an Early Repayment Charge.
If you choose not to get another fixed-rate or tracker mortgage, the lender is required to write to you again before your payment changes, to let you know what your new payments will be.
Discount Standard Variable Rate
As the name suggests, the rate you get is a discount on the lender’s SVR, for a set period of time. The discounted rate will move up and down, in line with the lender’s SVR.
There are other types of mortgages you can get with particular special features. You can read more about them on MoneyHelper: a government-backed provider of financial guidance.
If you’re looking to rent out a property, you can find out more about Buy-to-Let mortgages here.
READ MORE: Getting a Mortgage in Principle