Various types of mortgages are available on the market. Making the right choice could be overwhelming. If you are new to the mortgage industry, you will undoubtedly need a broker to walk you through it to ensure you sign a deal that serves your purpose.
You might need a fixed rate mortgage where the size of monthly instalments remains intact or a standard variable mortgage where monthly instalments fluctuate in relation to the changes in the base rate. You must know how each mortgage works before applying for them.
This blog discusses various types of mortgages and how they work. After knowing the rudiments of mortgages, you will be able to choose the best deal for you.
1. Repayment mortgages
Repayment mortgages are more affordable than any other type of mortgage as payments you make go towards both the principal as well as interest. The significant advantage of standard mortgages is that you own your house the second that you make the last payment. Because the monthly payment involves both the principal and interest amount, the debt diminishes and your equity increases.
These mortgages may be even more affordable if you have managed to make a larger deposit. Those who borrow up to 60% of the value of the house are likely to qualify for lower interest rates. Repayment mortgages involve fixed-rate and standard variable-interest-rate mortgages. They have both been explained down.
2. Interest-only mortgages
Interest-only mortgages are those where you pay only interest and therefore the principal amount does not diminish. The money you borrow is discharged at the end of the mortgage term. Although interest-only mortgages are available for both residential and commercial properties, they are ideal for the latter.
Here are the advantages and drawbacks of interest-only mortgages:
- As you are paying back only interest every month, the size of monthly payments will be quite low. You can easily make your budget around these payments.
- You will have better control over your investment, meaning you can better decide how you have to save money to pay off the capital at the end of the term.
- As the principal amount is not dwindling, you will have to pay interest on the full amount every time. It means you will end up paying much more interest in total than repayment mortgages.
- At the end of the mortgage term, you will end up paying off the whole principal amount in fell one swoop. So, while you are enjoying small monthly payments, you must make some arrangements to set aside that much cash.
- Interest-only mortgages are riskier than repayment mortgages. It is vital to apply for these mortgages only when you are completely certain about making the balloon payment. You will be facing adverse consequences if you fall behind on the payment.
Interest-only mortgages are considered risky mortgages compared to others. They follow strict affordability criteria. Further, these mortgages are convent for those who have large equities. It means they might not be ideal for first-time buyers. Most of the lenders will not approve your application for interest-only mortgages if you do not have a larger deposit.
3. Fixed-rate mortgages
Fixed-rate mortgages are quite popular among those who are getting on the property ladder. Interest rates remain the same for a fixed period of time. The fixed repayment period deals that lenders offer last until two years, three years or five years. Once the deal has expired, you will be put on a standard variable interest-rate deal. It means the size of monthly instalments will not remain the same. Interest rates change in relation to the base rate by the Bank of England.
Here are the pros and cons of fixed-rate mortgages:
- You might be able to qualify for these mortgages even if you do not have a deposit of more than 10% of the value of the house. However, in case of bad credit, you will be expected to pay double.
- You can easily manage payments as you do not have to worry about your budget. You already know how much you have to pay every month, so budgeting becomes easier.
- Fixed-interest mortgages may seem to be more affordable than variable-rate mortgages when the Bank of England increases the base rate.
- Fixed-interest mortgages charge slightly higher interest rates. You might be paying a bit more money in interest. They will cost you even more money if the base rate drops.
- With fixed-rate mortgages, you will not be able to refinance it unless the term is coming to an end. If you do so, you will end up paying hefty early repayment charges. Therefore, it is suggested that you do not choose a longer fixed repayment period.
- Remember that you will lose money if you port your mortgage while moving out to another house. You should always explore your options and carefully weigh the drawbacks. A broker could help you.
You should choose a fixed-rate period for not more than three years. Those with bad credit ratings will be able to recuperate their credit scores and then they would qualify for lower rates for variable-rate mortgages.
4. Tracker mortgages
Tracker mortgages are reliant on the base rate that the Bank of England charges. It means the tracker mortgage rate rises when the base rate goes up, and vice-versa. Tracker mortgages always charge interest rates a few points above the base rate. They are similar to variable interest-rate mortgages because the size of monthly instalments cannot be the same. The interest you will be paying on your mortgage throughout the term might increase or decrease several times.
Here are the advantages and drawbacks of tracker mortgages:
- Monthly payments will automatically fall when the base rate drops. It will more likely help you save money.
- They are considered more affordable than standard variable mortgages. Your lender cannot increase interest rates more than the base rate.
- Tracker mortgages are not subject to early repayment charges, so you can easily move out.
- They are considered expensive if the base rate goes up.
- You may find it a bit complicated to budget when you do not know how much you have to pay every month.
It is always suggested that you consult a broker while using tracker mortgages. Your credit report should be excellent and make sure you do not owe even a small debt like instant no guarantor loans while taking out a tracker mortgage.
5. Standard variable-rate mortgage
Standard variable mortgages are the most expensive mortgages. In fact, fixed-rate mortgages are switched to standard variable mortgages after the end of the fixed-period deal. The interest rates are unpredictable as they can be changed at any time.
Although interest rates are subject to a change in the base rate, lenders do not have to strictly follow the norm. Therefore, they could be even more expensive than tracker mortgages. It is highly advisable that you consult a broker when choosing a standard variable mortgage. Here are the pros and cons:
- The arrangement fee is lower.
- They are not subject to early repayment charges.
- Repayments could diminish with interest rates.
- They are expensive because, unlike tracker mortgages, they could charge interest rates more than the base rate.
The final statement
There are several types of mortgages available on the market. It is always recommended that you carefully evaluate your options before applying for one.
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