There are pros and cons to different types of mortgages as well as features that may appeal to one type of borrower but could be the wrong choice for another.
In this article, we will explain the different types of mortgages you can arrange; how each type of mortgage works and ways to choose the right mortgage for you. For a brief summary of the different mortgage types, see the below video.
What is a mortgage?
A mortgage is a specific type of loan used to borrow money that will fund the purchase of a property. Depending on the kind of purchase you are about to make, you will first choose between the following mortgages:
- Residential mortgage - a loan used to buy a property that you will live in
- Buy-to-let mortgage - a loan used to buy a property that you intend to let out for someone else to live in
- Self-build mortgage - a loan used to buy property to purchase land and build your own home
- Commercial mortgage - a loan used to buy a property that will be used for commercial purposes
For the purposes of this article, we will focus on residential and buy-to-let mortgages.
How do mortgages work?
A mortgage allows you to purchase a property by taking out a loan. For example, if your house purchase price is £200,000 and your mortgage loan amount is £180,000, you pay £20,000 from your savings as the deposit on your home and the remaining £180,000 is borrowed as a mortgage. The mortgage lender will charge you interest on the loan amount of £180,000.
There are also 3 types of mortgages that determine how your mortgage will be repaid, and we list these below:
- Interest-only mortgage - Each month you will only pay the interest that accrues on the amount that you borrow so the outstanding balance doesn't reduce but your monthly payment is smaller than what you would pay if you were to choose a repayment mortgage.
- Repayment mortgage - You will pay the interest that accrues and some of the capital that you borrowed so the outstanding balance reduces over time but your monthly payment will be larger than what you would pay if you were to choose an interest-only mortgage.
- Part repayment, part interest-only mortgage - A hybrid type of mortgage where you split your mortgage balance into 2 parts where you pay one part as interest-only and the other as repayment.
There are a number of other factors that are important to consider before you decide which type of mortgage you should get. It is a good idea to weigh up the pros and cons of each type of mortgage before making a decision. If you are unsure, it is also a good idea to speak to a mortgage broker* who can help you to make an informed decision on the best type of mortgage for your personal circumstances.
What are the different types of mortgages?
In this section, we list the different types of mortgages available. Read our article to find and compare the best mortgage rates.
| Mortgage interest rate type | Mortgage payment stays the same each month | Will I benefit if the Bank of England base rate is reduced? | Am I protected against an increase in the Bank of England base rate? |
| Fixed-rate mortgage |  |
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| Tracker or variable rate | |
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| Standard variable rate | |
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| Discounted mortgage deal | |
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Fixed-rate mortgage
A fixed-rate mortgage is one where the interest rate is fixed for a period of time. You get to pick the term that it is fixed for and it is guaranteed not to change during the fixed period. The most common fixed-rate periods are 2,3,5 or 10 years but it may be possible to fix for longer periods of time. During the fixed period, the mortgage company cannot change the rate, even if the Bank of England base rate increases which means you will know exactly how much you will pay each month until the term ends.
Pros
- Your monthly mortgage payment will remain the same for the deal period
- Your payment will not increase if the Bank of England base rate increases during your deal period
Cons
- Your payment will not reduce if the Bank of England base rate reduces during your deal period
- You will usually have to pay an early repayment charge and exit fee if you change mortgage deals before the fixed period ends
Tracker mortgage
A tracker mortgage is a mortgage where the interest you pay on the mortgage loan tracks the Bank of England base rate. With a tracker mortgage, the interest rate you pay is the Bank of England base rate plus a markup fee added on by the mortgage company. Some tracker mortgages have a collar which means that the interest rate cannot drop below a certain amount and they may also have a cap which means that the interest rate will not exceed a certain percentage either.
Pros
- Your monthly mortgage payment can reduce if the base rate of interest reduces
- Your rate may be capped so that it doesn't exceed a capped interest rate allowing you to predict the highest possible rate you could be charged
Cons
- Your monthly mortgage payment will increase if the base rate of interest increases
- If your deal includes a rate "collar" this will prevent your rate from reducing past a certain level if interest rates fall a lot
Standard variable mortgage
A standard variable mortgage means you will be paying the standard variable rate of interest which is the lender's default interest rate. This is the mortgage that you have once your existing mortgage deal has come to an end. Most people avoid being on a standard variable mortgage by remortgaging when their mortgage deal comes to the end.
Pros
- Your monthly mortgage payment can reduce if your lender's standard variable rate reduces
- You won't usually need to pay an early repayment charge to switch to a different mortgage
Cons
- Your monthly mortgage payment will increase if your lender's standard variable rate increases
- Standard variable rates are usually higher than fixed, tracker or discounted rates so your monthly mortgage payment is likely to be more expensive
Discount mortgage
A discount mortgage is where you get a reduced rate at the beginning of your mortgage term for a period of time, e.g. two years, and then after that period, you will be moved onto the lender's standard variable rate (SVR). The standard variable rate is the default rate the lender charges all customers not tied to a fixed rate. With a discount mortgage, the lender can change their SVR at any time, so you will still receive the discount, but it is normally a percentage of the SVR. Therefore, your monthly mortgage repayment is likely to change.
Pros
- Your monthly mortgage payment may reduce if your lender reduces its standard variable rate during your fixed deal period
Cons
- Your monthly mortgage payment may increase if your lender increases its standard variable rate during the fixed deal period
- You will usually have to pay an early repayment charge and exit fee if you change mortgage deals before the fixed period ends
Additional mortgage features
Once you have chosen the mortgage interest type, you can choose additional features that may suit your particular circumstances. We list some of these below.
Offset mortgage
If you have a savings account and a mortgage with the same bank or building society, you may be able to offset your savings against your mortgage with an offset mortgage. This means that you will stop receiving interest on the savings that you have, but instead pay a reduced amount of interest on your mortgage. For example, if you have a £200,000 mortgage and £20,000 in savings, you may only have to pay interest on £180,000 of the mortgage. You can choose between a number of mortgage deals when offsetting your savings against your mortgage loan including fixed-rate, tracker, discount and variable-rate mortgage deals.
Pros
- You can maintain access to your savings while benefitting from paying no interest on the equivalent amount of your mortgage
- You can build up your savings pot towards paying off your mortgage without actually doing so, offering flexibility
Cons
- You may miss out on investment returns that could be higher than the amount of interest you are able to offset by keeping your savings in an account
- By keeping your savings and not using them towards your mortgage balance, you may not be benefitting from the best rates as your loan-to-value (LTV) will be higher than it could be
Guarantor mortgage
A guarantor mortgage is when a person agrees to be a guarantor on the mortgage debt, which means that they become responsible for the debt if the homebuyer cannot keep up with the mortgage payments. Guarantor mortgages can be useful for potential buyers that need a helping hand to get onto the property ladder and can be secured against the guarantor's property or savings.
Pros
- Can help those struggling to get onto the property ladder
Cons
- This type of mortgage is high risk for the guarantor as they could lose their own home or savings if the homebuyer cannot pay the mortgage
- Guarantor mortgages are usually subject to higher repayments as they are typically more expensive than most standard mortgages
- There is less choice
How to choose the right mortgage type
The best way to assess which type of mortgage is best for you is to speak with a mortgage expert*. A mortgage broker or mortgage adviser will not only scan the market for the best mortgage deals based on your circumstances, but they will also assess your finances to make recommendations based on your priorities. For example, if you are on a fixed budget and would not be able to cope with any increase to what you pay each month for your mortgage, you may need a certain type of mortgage. A mortgage adviser will help you to weigh up the pros and cons of each type of mortgage so that the mortgage you choose serves your needs appropriately.
If you do not have a personal mortgage broker, you could use the online mortgage broker, Habito*. Habito provides an online mortgage comparison tool and you can request to speak with a mortgage expert to help you with arranging your mortgage too. They have access to over 90 lenders so you will be able to access a wide range of mortgage deals without having to do the difficult work yourself.
Alternatively, VouchedFor* provides you with a search tool to source a mortgage broker in your area. You will be able to read reviews about the mortgage broker to help you make your selection.
If a link has an * beside it this means that it is an affiliated link. If you go via the link, Money to the Masses may receive a small fee which helps keep Money to the Masses free to use. The following link can be used if you do not wish to help Money to the Masses - Habito, VouchedFor
