Buying a home is one of the biggest financial decisions you will ever make, and choosing the right mortgage plays a critical role in the process. With so many options available, it can be overwhelming to figure out which type of mortgage is right for your financial situation.
Unless you can buy your home entirely in cash, you’ll likely be paying back your mortgage over a long period of time, so it’s important to find a loan that fits within your budget. Today we will explore the various types of mortgages and help you determine which one is the best fit for you.
The two main parts of a mortgage are the principal, which is the loan amount, and the interest charged on that principal.
1. Fixed-rate mortgage
A fixed-rate mortgage has an interest rate that remains fixed for a certain period of time. This timeframe can vary from two years and all the way up to 10 years in some instances. This is a good option if you want predictable monthly payments, as regardless of what happens elsewhere, your repayments will remain the same each and every month until the term comes to an end. At the end of this term, the mortgage will then revert to the lender’s standard variable rate (SVR) and you’ll be able to switch lenders or apply for another fixed rate term with your existing provider.
However, should mortgage rates drop, you’ll be left paying off your loan at a higher interest rate while others benefit from lower monthly payments. Additionally, you will be committed to the mortgage term, which means that if you want to pay off, switch, or terminate the mortgage before the agreed-upon timeframe, you will be subject to an early repayment charge.
2. Repayment
Repayment mortgages serve as a foundation for majority of mortgage options available on the market. They are the most prevalent type of mortgage and their principle is straightforward. You obtain a loan from a lender and repay it over a period of time, which could be as long as 40 years but typically ranges from 20 to 30 years. Every month, your payment will cover a portion of the borrowed principal and part of the interest attached to the loan.
When discussing long-term mortgage commitments, it is likely that you may want to relocate before the mortgage term expires. In this situation, you have two options: you can transfer the mortgage to your new property or pay off the remaining balance and apply for a new mortgage for a new property.
3. Interest-only
While most mortgages are structured as repayment mortgages, interest-only mortgages work in a completely different way. With an interest-only loan, you only pay back the interest on the mortgage each month, without making any payments toward the principal amount borrowed. While this can sound attractive due to the lower monthly payments, it means that you will still be responsible for repaying the entire borrowed amount at the end of the loan term. If you do not have the funds to pay off this capital, you may be forced to sell your home.
To cover the repayment of the principal amount, buyers who choose interest-only mortgages often opt for high-interest fixed-rate savings accounts that lock in their money until the loan term expires. However, it is important to note that lenders may require you to provide a detailed plan for paying off the borrowed capital before approving your loan application. It’s crucial to keep this in mind before approaching a bank or building society for an interest-only mortgage.
4. Variable rate
Lenders typically have a standard variable rate that serves as the benchmark for all their other mortgage products. Once your fixed-rate mortgage term ends, your interest rate will revert to this variable rate, which is the lender’s basic mortgage offering.
The “variable” component refers to the interest rate charged on the loan, which can fluctuate in either direction. Variable-rate mortgages are loosely tied to the Bank of England’s base rate, but they are also subject to the lender’s own criteria. This means that your rate could increase even if the BoE’s rate remains constant. Low-risk borrowers may find this option attractive since variable-rate mortgages typically have lower interest rates than fixed-rate mortgages, resulting in lower monthly payments.
5. Trackers
Tracker mortgages, in contrast to SVRs, are linked to a specified interest rate by a predetermined amount, either above or below the selected rate. The interest rate typically tracked by these mortgages is the Bank of England’s base rate. This implies that if the BoE raises or lowers interest rates, your mortgage payments will follow suit.
It’s important to note that lenders may specify a minimum base rate for the loan, regardless of the BoE’s actions, while not imposing a limit on the maximum rate. This implies that the lender is protected by a basic profit margin, but you have no protection against your payments increasing significantly.
If you are a first-time buyer, a tracker mortgage could be a good option if rates are low, but it might be wise to find a deal with a cap if you’re not sure you could make higher payments should the rates increase.
6. High percentile
High percentile loans, also referred to as 95% or 100% mortgages, are designed for individuals who are unable to raise a substantial deposit to purchase a property. These largely disappeared from the market following the 2007 crisis, but are now slowly re-emerging. The Help to Buy scheme introduced in 2013 provides an opportunity for those who cannot meet the usual 10% minimum deposit requirement, but it’s not without risk.
Opting for such a loan exposes buyers to the risk of negative equity since they lack the buffer of a substantial deposit. Even a minor decline in house prices can result in the mortgage amount exceeding the property’s value. Consequently, lenders may increase rates to cover their risk exposure, which can make monthly repayments quite expensive.
While individuals who struggle to raise a deposit may view these mortgages as a viable solution for purchasing their first property, they should be aware of the risks associated with such loans before committing to them.
7. Buy-to-let
Buy-to-let mortgages cater to those who intend to purchase property for the purpose of renting it out rather than residing in it. The computation process for a buy-to-let mortgage is distinct from the other types discussed as the lender will usually take into account the potential rental income of the property when determining the amount they are willing to loan.
When choosing a mortgage, it is important to consider your financial situation and long-term goals. A mortgage professional can help you navigate the various options and choose the right one for you. Remember, a mortgage is a long-term commitment, so take the time to do your research and choose wisely!
