The different types of mortgages

Different Types of Mortgages

Interest is applied to the mortgage loan in a number of different ways.

Which one you choose will depend on whether and how you are happy to gamble on bank base rates for interest purposes or whether you want to know exactly how much you will pay each month for the length of the mortgage term.

The main ways in which interest is applied are:

Standard Variable Rate Mortgage (SVR)

This is a lender’s most basic “plain vanilla” product and will usually be a higher rate than the base rate set by the Bank of England to allow lenders to make a profit. As the SVR usually mirrors movements in the base rate, a big rise by the Bank will mean a sharp increase in your repayments. This could of course work the other way also, although lenders are not required to pass on the full savings to you if the base rate falls.

Fixed Rate Mortgage

For these deals you agree to accept a rate that is usually fixed for a period of two, three or five years or sometimes longer. This means you will know exactly how much you will be paying out each month and your repayments are guaranteed to stay the same for the agreed period, regardless of what happens to interest rates. The main problem here is that while the rates can be competitive they can also be higher than some other products and you will not enjoy any benefit should the base rate fall. You are paying for the security of knowing that your premiums stay the same.

Tracker Mortgage

Although similar to SVR products - in that the rate fluctuates according to changes in the base rate - tracker mortgages will follow these movements exactly – up and down. If the base rate goes up 2%, for example, then you’ll be paying an extra 2%. The rates offered are pretty competitive but you must appreciate you’re susceptible to changes – good and bad – in the base rate so there is more risk.

Hybrid Mortgage Products

You will probably come across other mortgage products. These include capped products where the rate you pay moves in line with the base rate, but you are given some protection as there is an upper ceiling in place. Depending on your financial circumstances, flexible and offset mortgages could also be valid alternatives.

Flexible Mortgage Products

These come in all shapes and sizes and allow you to make overpayments and take a break from paying your repayments for agreed periods. Rates are usually slightly higher than fixed and discounted loans.

Discounted Mortgages

These are best defined as mortgages which have a discounted variable rate of interest for a set period, after which the rate charged will rise. These can save money in early years but watch “lock-in” periods when you must pay the usually higher variable rate.

Offset Mortgages

These relatively new mortgages enable borrowers to keep their savings in a pot alongside their mortgage which will “offset” the loan interest while the money is in their account.

For example, if you have a mortgage of £160,000 and savings of £30,000, you will only pay interest on £130,000. This means you should be able to clear the debt quicker and can usually overpay or, in some cases, underpay too as long as you make up the difference over time. On the flip side, your savings will not be earning any interest.

So how much could be saved? Well, take the example of someone with a £150,000 mortgage on a £200,000 property, with a 3.75% tracker rate over 25 years on a repayment basis. If they had £20,000 in a savings account and used it to overpay – or offset – their mortgage their monthly payment would be £771.20 and with an average balance of £1,000 in a current account they would repay a total of £203,821.64 and pay off their mortgage in 22 years and 1 month. Without offsetting, they would repay a total of £231,358.42 and pay off the mortgage in 25 years. So they would save nearly £30,000 and nearly three years in payments.

The key message is that you can make your extra money work much harder for you by using it to overpay your mortgage. By using the flexibility of an offset mortgage, you ensure the funds remain accessible if you ever have an emergency. Rates can be higher, however, and you pay for the extra flexibility. They are well worth considering if you have savings, decent earnings and want to repay your loan early.

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