Types of Mortgage

Today, we will be delving into the world of the Mortgage, identifying what:

  • Types are available
  • General definition
  • Benefits
  • Drawbacks

The aim of this document is to help choosing a Mortgage that fits your requirements.

The main types of Mortgage available in the UK today are:

  • Fixed Rate Mortgages
  • Tracker Mortgages
  • Discount Mortgages
  • Standard Variable Rate [SVR] Mortgages

General Definition

The essential part of a fixed rate mortgage is the fixed interest rate itself. While other mortgages rates fluctuate as the market changes, a fixed rate mortgage provides you with the financial

stability of having fixed calculated installments every month.

This prevents you from worrying about an increased rate causing increased expenses. Your repayments will stay the same and are not influenced by bank rates or SVR increases by your lender.

The length of a fixed term mortgage normally ranges from two to five years but can be longer depending on the type of vehicle you employ to approve it. When the fixed term ends, you will be transferred to the SVR of your lender. It’s important to pay attention when you are coming to the end of the fixed term as moving on to your Lenders SVR may increase your repayments if the SVR is significantly higher than the fixed rate.

Benefits

Knowing for a period ranging from 2 to 5 years [in most cases], that your mortgage rate and monthly payment will not change is the most significant part of a fixed rate mortgage regardless of rate fluctuations in the market.

Should rates rise quickly, you’ll still be paying the same amount. This makes financial planning easier as you can budget your expenses and plan your holidays or investments without any

surprises. Based on all of this, a fixed rate mortgage might be the best option for you, whether your budget is tight, or you prefer the certainty and peace of mind it provides. 

Drawbacks

Currently, fixed-rate mortgages are a bit more expensive due to the low rate environment. Except that, the only drawback of fixed-rate mortgages is the scenario of dropping rates. Should the SVR drop during your fixed term, this won’t be saving you any money.

General Definition

The tracker mortgage can last for a year or the total life of the loan. This type of mortgage tracks the Bank of England’s base rate at a set margin (for example 1%), hence the name tracker mortgage. When your tracker deal ends, you’ll normally be transferred onto your lender’s SVR.

Benefits

Under specific economic circumstances, for example the current historically low base rate, you’ll be able to get tracker mortgage deals with low-interest rates. With a base rate of 0.25% and a +1% tracker mortgage you’ll be charged only 1.5% interest. When rates are low, you can overpay your mortgage which allows you to pay it off in a shorter period.

This profits you too, as shortening the time cuts the interest due to be paid. While the tracker mortgage is not completely fixed, it is not affected should your lender change the SVR.

Drawbacks

Should the base rate change, your rate will change too. This means a tracker mortgage cannot offer total fixed rate security. Whether you’re currently in a tight place financially, or

need to know your monthly payments in exact numbers, the tracker mortgage would

not be as good of an option as the fixed one. Also, leaving a tracker mortgage mid-term is likely to cause extra fees for early repayment.

General Definition

Another mortgage leaning towards using variable rates is the discount mortgage where “Discount” is used as a description of the interest rate set below the lender’s SVR for a limited period.

Having a discount rate of 1% you’ll always have a rate of 1% less than your lender. At a SVR of 5%, you’ll be paying 4%. Should it raise to 6%, you’ll be paying at a rate of 5%.

Normally, discount mortgages last between two and five years and afterwards, you’ll be transferred to your lender’s SVR.

Benefits

What’s great about this mortgage is you will have a discount on your lender’s SVR for the length of the deal. Should the SVR be particularly low, your rate will be even lower. Whether rates increase or decrease your rate will always be that much lower than your lender’s SVR.

Drawbacks

A discount mortgage does not offer much stability as its rate is based on your lender’s SVR. Should your lender set a high rate, your rate will increase accordingly.

Additionally, having large discounts make you vulnerable at the end of the term.

A sudden increase in rate as you transfer from the discount mortgage to the lender’s SVR may lead to increased costs for the rest of the loan. Should you require stability and predictability, having a fixed rate mortgage provides you all of that. Leaving a discount mortgage deal before its end will cause early repayment charges.

General Definition

Having a SVR mortgage is often risky and not necessarily a beneficial option. The SVR mortgage is a variable rate mortgage that follows your lender’s default rate. Your rate will follow

that of your lender, meaning you can’t influence or control it. Before choosing this option I would highly recommend that you do some proper research on your lender.

Due to its risk, this type of mortgage is not a good option when you’re in a difficult financial situation where money may often become tight. 

While SVR tend to be influenced by the base rate of the Bank of England, lenders are free to change the SVR as they wish. Among serious lenders, you will find rates ranging from

2-5% above the Bank of England base rate.

Benefits

During the past five years, the Bank of England base rate has been historically low. As a consequence of this, lenders have cut their SVRs. If you’re currently on a low SVR, staying on this might be a better option than going elsewhere. Another positive aspect of the SVR mortgage is they often don’t have charges should you want to end the deal. This leaves you with the freedom of analyzing, reviewing and renegotiating your mortgage terms at any given time.

Drawbacks

Regardless of current rates, having a SVR mortgage is risky business. Your rate is in the hands of your lender, offering no security to you as a customer. Should you be in a tight, financial situation you might find yourself cornered once the rates increase. If this sounds like your current situation; find yourself new terms before it’s too late.