Types of Mortgages Explained: Which One Is the Best for You?

With any types of mortgage, you’re essentially repaying two parts of it: the capital (the actual amount borrowed) and the interest. There are two basic ways to repay these parts:

• With interest-only, your monthly payments only cover the interest, and you pay the capital in one lump sum at the end of the term (usually by selling a property or through savings).

• With repayment mortgages, your monthly repayments include both the capital and the interest so you repay everything by the end of the term through your monthly instalments.

While most mortgages on the UK market currently fall within the repayment category, the highest rates since 2008 are fueling curiosity about interest-only mortgages.

So let’s get into both in detail.

Repayment mortgages

Repayment mortgages are straightforward – your monthly repayments go towards covering both the capital and the interest, and after an agreed number of years (the mortgage term), your mortgage is fully paid and you own your property.

Interest rates are typically lower compared to interest-only, while monthly repayments will be higher. The mortgage term is usually 25 years. However, due to the way interest is compounded, longer terms come with more interest paid, even though they cost less per month.

Interest-only mortgages

Another way to pay for a mortgage is the interest-only model. In this case, you pay for interest only each month during the agreed mortgage term, and after that, you repay the entire sum you borrowed in one single payment.

The interest rates for-interest only mortgages are typically higher, although monthly repayments are lower as they do not go towards repaying the actual money you borrowed.

Instead, you repay it by remortgaging, selling the property, or using your savings and investments. You will need to provide the lender with your repayment strategy as you apply for an interest-only loan.

The difference between variable-rate and fixed-rate deal is simple. With fixed-rate mortgages, the interest rate doesn't change during the agreed-upon period. With variable-rate, the interest rate can increase or decrease.

Fixed-rate mortgages

Fixed-rate mortgages have rates that stay the same for a set period of time. Usually, these terms last from two to five years, but there are also longer terms of ten years and more. In the UK, most outstanding mortgages are fixed to five years.

So if you have a five-year mortgage, your rate is locked in for five years, after which you are moved to the lender’s standard variable rate (usually until you strike a new deal).

If you want to switch from a variable to a fixed-rate mortgage, you can technically do so at any time. However, this would require a full remortgage with the current or a new lender, which could come with significant fees if you are still in the introductory or discounted period.

When it comes to interest rates, a longer fixed rate period proves to be more expensive than short periods. Also, fixed-rate deals tend to have higher rates than variable-rate deals, although not as high as SVRs.

Variable rate mortgages

A variable rate mortgage is a type of mortgage in which your interest rate, and as a result, your monthly repayments, can increase or decrease. Your interest rate can change at the lender’s discretion, usually (but not always) following changes to the BoE bank rate.

Variable-rate mortgages usually have introductory periods during which there are special conditions: discounts, tracker rates, or capped rates. These can last between one and five years, depending on the subtype of variable mortgage.

Although they can have lower starting rates than fixed-rate mortgages, the rates tend to go up later. Essentially, they depend on the state of the market and economy.

Variable rate mortgages come in several subtypes –SVRs, tracker mortgages, discount mortgages, and capped-rate mortgages.

• Standard variable rate (SVR) mortgage

The standard variable rate mortgage is the mortgage deal you end up on after your introductory period is over. This rate is typically quite high, so people usually remortgage or find a new deal once they’re moved onto the SVR. An SVR does offer full flexibility, so you can overpay or switch to other deals with no penalties whatsoever.

• Tracker mortgage

The rate for a tracker mortgage is determined by adding a pre-arranged percentage on top of another interest rate (usually BoE base rate). This in turn affects your monthly repayments. Some tracker mortgages also have an interest rate collar, which is the minimum rate the lender will offer even if the bank rate drops.

• Discount mortgage

A discount mortgage is just like an SVR but with a discount that lasts for a set period, usually two to five years, with some lenders offering up to ten. To determine the rate, check your lender’s SVR.

• Capped-rate mortgages

Capped-rate mortgages have a limit which the interest rate cannot exceed during the arranged period, regardless of what happens with the lender’s SVR. You will know that your monthly repayments cannot go over the maximum, and if the SVR goes down, you can see the rate dropping, too. Capped-rate mortgage terms last between two and five years, after which you’ll be moved to the SVR.

Offset mortgages are a type of mortgage connected to your savings account. The money in the account is used to offset the amount on which you pay interest. For example, if you need a loan of £200,000, and you have £20,000 in your savings account, you will only pay interest on £180,000. You can still use the money in your savings account, but this will affect your interest.

The maximum LTV tends to be lower at about 80% maximum. However, offset mortgages are harder to find and come with higher interest rates. You can also find family offset mortgages and buy-to-let offset mortgages.

If you only have a deposit of 5% of the property value or no deposit, repayment mortgages with an LTV ratio of 95% to 100% present an opportunity. They are intended for first time buyers, but other people can get them too. They are, however, riskier and have higher interest rates than mortgages with bigger deposits, even if it’s just 10%.

Zero-deposit mortgages are not easy to find and have strict affordability rules. However, they can still be found among guarantor mortgages, family deposit mortgages, and student mortgages.

Flexible mortgages provide more options for easier switching between deals, overpayment, underpayment, daily interest calculations, and even mortgage payment holidays, during which you can pause your payments (although the interest is still charged). Due to this, they are sometimes referred to as mortgages with no early repayment charges.

Flexible mortgages might suit borrowers with a fluctuating income: those who are self-employed, on zero-hour contracts, a commission-based income, or large bonuses they would like to use to overpay. However, the flexibility is usually paid through higher setup fees or interest rates.

A buy-to-let mortgage is a type of mortgage intended for buying rental properties and repaying through rental income (affordability calculations include other types of income, too). It usually requires higher deposits (at least 25%), and comes with higher interest rates, and setup fees.

BTL mortgages are available as interest-only and repayment mortgages and are not designed for people with lower credit scores or income. With lenders being extra cautious, BTL options for first-time buyers are often limited.

Joint mortgages can be taken by two to four people who are all responsible for payments and are usually taken by partners. The joint borrowers become financially linked, affecting one another’s credit scores.

Given that people can join forces to get a bigger deposit, they can get a better LTV ratio and therefore better interest rates. Moreover, joint borrowers can usually get bigger loans as lenders take the combined income into account.

There is another type of mortgage: joint borrower, sole proprietor mortgages, where more people make the monthly payments, but only one owns the property in the end. A JBSP mortgage usually helps first-time buyers get better deals and borrow more money as the other borrower typically has a better credit score and higher income.

These are typically repayment mortgages. However, they are difficult to come by and it’s best to use a specialist broker.

A guarantor mortgage allows people with poor credit scores, no credit history, or with issues to save enough for a deposit to get a mortgage. A guarantor helps them by providing additional security, whether it’s savings, income or property.

A guarantor doesn’t make monthly payments unless the borrower isn’t able to. Unlike with a joint mortgage, they have no property rights. These are repayment mortgages.