What type of mortgage should I get?
There are literally thousands of different types of mortgages on the market, and choosing one can be daunting. But before deciding which mortgage to go for, you need to decide what type of mortgage to get – repayment, interest only, fixed, tracker or discounted. Which one is right for you depends on your circumstances. Get the wrong one, and it could cost you thousands.
Should I go for a repayment or an interest-only mortgage?
For the vast majority of people, repayment mortgages are best – they guarantee you are paying off your debt, and ensure you will have repaid the mortgage at the end of its term.
Interest-only mortgages were very popular a few years ago, primarily because the monthly costs were a lot less, since you don’t repay a chunk of capital each month – you only pay the interest. However, in more recent times, with tighter lending criteria, it is becoming increasingly difficult to take out interest-only mortgages. A handful of lenders will allow you to take part of the loan on an interest only basis however you’ll usually need a very large deposit and a concrete plan of how you will repay the mortgage.
Should I go for a fixed rate mortgage?
Getting a fixed rate mortgage means you have the security of knowing exactly what you’ll be paying each month. The rate is fixed for a number of years, after which it reverts to the lenders standard variable rate. Between 50% and 75% of new mortgages in the UK are fixed rate.
You generally pay more for a fixed rate than a variable rate, but you might win out if the Bank of England puts up interest rates.
If interest rates fall, then you might get frustratingly trapped in a higher rate mortgage.
Fixed rate mortgages almost always come with early redemption penalties, which can be very onerous – are you sure you are not going to need to move in the next two or five years?
If I do opt for a fixed rate, how long should I fix for?
If you do decide to go for a fixed rate mortgage to guarantee your mortgage costs, you need to decide the term of it – normally two, three or five years.
Five years gives greater certainty, and can be appealing for people in stable but financially stretched circumstances who want to minimise any financial risks. But a lot can happen to your circumstances in five years, and you may end up feeling trapped by it. Also, in five years your income may have increased, making any mortgage increases far more affordable.
Similarly, the huge expenses involved in moving house – such as buying furniture and building work – will normally be behind you after two or three years, giving you greater capacity for coping with changes in interest rates so a two or three year fix should be a good option.
Should I opt for a tracker rate?
Tracker mortgages go up and down with the Bank of England base rate. For example, you can have a tracker that is base rate plus 2%, meaning the interest you pay will always be 2% above the Bank of England base rate.
Tracker rates can be for the entire length of the mortgage, or just for an introductory period (between two and five years) after which the rates revert to the lender’s standard variable rate (which is invariably a lot more expensive).
Base rate trackers have the great virtue of transparency, as well as taking an element of uncertainty out of standard variable mortgages. You know that if the Bank of England cuts rates or raises them by 0.25%, then your mortgage rate will fall or rise by that amount.
Mortgage lenders have been criticised for not passing on interest rate cuts to customers on standard variable rate mortgages, and also for putting up their own rates even when the Bank of England hasn’t. Tracker mortgages do away with that element of unpredictability: when the mortgage goes up, you will know why.
Trackers can be astonishingly good value – lenders have even offered them at below the Bank of England base rate (meaning that you are borrowing the mortgage at interest rates less than banks can borrow from the Bank of England). In some highly unusual cases, this meant that people have had their mortgage rates literally cut to zero, with one couple celebrating a monthly mortgage payment of 1p a month.
Because trackers respond to changes in the Bank of England base rate, they are still unpredictable. For homeowners on a tight budget, it might make more sense to start off with a fixed rate mortgage rather than a tracker.
Should I choose a Standard Variable Rate mortgage?
Absolutely not! To put it bluntly standard variable rate mortgages are the worst value mortgages you can get.
The standard variable rate (SVR) is the main interest rate that a mortgage lender charges its customers. Mortgages normally revert to the SVR after introductory periods for discounted rates, or as fixed rate deals or trackers come to an end.
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Each mortgage lender has complete freedom to set their own SVR. The factors they take into account include the Bank of England base rate, the profit margins they want to make, the amount of savings they are taking in, and the costs of borrowing from the international money markets.
SVRs are generally about the most expensive type of mortgage on offer – they are far higher than the Bank of England base rate, and the various forms of introductory offers. Mortgage lenders rely on the inertia of homeowners to keep them on SVR once they have ended up on it. If you end up on an SVR, you should generally look at whether you can save money by remortgaging.
Is a discounted mortgage a good option?
Because SVRs are usually uncompetitive, mortgage lenders often attract new customers by offering discounted mortgages. These will offer a discount to the SVR for an introductory period – usually between 2 and 5 years – before you revert again to the SVR.
These discounted mortgages can be very useful for people struggling with the high costs of homeowning in the first few years after buying. They don’t have the certainty of fixed rates, but are usually lower.
You can also get combinations such as discounted tracker mortgages, which can be very competitive.
While you may enjoy a great discount on your mortgage as soon as the discounted rate ends you’re likely to be in for a payment shock when you revert to your lender’s SVR.
Should I consider an offset mortgage?
Offset mortgages can help you to reduce the amount of interest you pay on your loan. The mortgage is linked to your savings or bank account and your mortgage lender will calculate the interest you owe based upon the total amount borrowed, minus however much money you have in the linked accounts.
As an example, if you have £10,000 in savings, and a £100,000 mortgage, you would only pay interest on £90,000.
An offset mortgage makes your money works hard for you all the time, as well as giving you the flexibility to pay off more of the mortgage when you have more money, but then to reduce your payments when you need a bit more to spend.
While your savings and cash will help reduce the amount of interest you pay you won’t be able to earn any interest on them. What’s more offset mortgages tend to have slightly higher interest rates.
Read more about off-set mortgages and see if it’s right for you in our guide Should I get an offset mortgage?
First Time Buyer and Guarantor mortgages
Many mortgage companies have special deals for first time buyers, which are generally aimed at helping people get on the property ladder – they usually accommodate having lower deposits (ie the ratio of the mortgage to the value of the property can be higher) and have lower application fees.
They are often discounted as well, to make the early years cheaper (but you may pay it back later). In general, these first time buyer mortgages can be very helpful at a difficult time – but do still check out the rest of the market in case there are some particularly good deals.
Some lenders will allow your parents or a relative to provide a guarantee for your repayments – essentially that if you can’t meet them they will. These are called Guarantor Mortgages and can mean you can borrow a larger amount than you would be able to on your own.
If this is your first mortgage, see our steps to your first mortgage guide and, if your parents may be in a financial position to help you, see The Bank of Mum and Dad – how to help your child buy a home.
Should I go for daily calculation or annual calculation of interest?
Mortgage lenders generally calculate the amount of interest you are due to pay daily, monthly or annually. Without hesitation you should go for daily calculation, and avoid any mortgage with annual calculation.
It seems like a nerdy point, but mortgage lenders have relied on confused borrows to have interest calculation methods that are blatantly unfair and add many thousands of pounds to a cost of a mortgage. It has only been as a result of media outrage that they changed their methods, but some still haven’t.
With annual interest calculation, the lender calculates how much interest you should pay each month only once a year – often at New Year – and then carry on charging that throughout the year, even though you are most likely paying down the mortgage each month, and possibly making one-off capital repayments. For example, if they calculate your interest payment on 1st January, and you pay off £5000 on 2nd January, they will charge interest on that £5000 you have repaid for a whole year until they calculate the interest again the following January 1st.
If you get a mortgage with annual interest calculation, the lender will still be charging you interest on debts that you have repaid. This is legal but morally questionable, and will mean you end up paying many thousands of pounds more over the term of the mortgage. Avoid.
Should I choose a bank or building society?
After the demutualisation wave of the 1990s, the building society movement in the UK is a shadow of its former self. The building societies – which are owned by their customers – often claim that they give better value for money because they don’t have to pay dividends out to shareholders every three months. This may be true, but it certainly isn’t guaranteed, and the proof has to be in the pudding. If you get a better deal from a building society than a bank, then go for it. If you don’t, don’t.
A mortgage broker can be a good idea as they can advise on the type of mortgage that best suits your needs and compare the range of mortgage offers available across the market.