What are the different types of mortgages?
When looking for a mortgage, whether as a first time buyer, remortgager or even moving into ‘buy-to-let’ the sheer choice of products can seem extremely overwhelming. There are so many different products to choose from, each with different interest rates, fees and flexibility and your choice will affect how much your total mortgage costs you, and how long it will take you to pay it off, so making the right decision is critical.
At Contractor Financials, we don’t believe in a one size fits all approach to advice and take the time to tailor mortgage products to your needs as a contractor. Below we explain the differences of each type of mortgage, as well as the pros and the cons to help you work out which may be the best option for you. Our award winning mortgage advisers are on hand to help you make the right decision first time so feel free to contact us if you have any questions.
Fixed rate mortgages
A fixed rate mortgage gives you security of knowing that regardless of what happens in the market, your payments and interest rate will stay the same for an agreed period of time. There are 2, 3, 5 and even 10 year fixed deals and they all essentially protect you from rising interest rates for the initial fixed period.
However, you will not benefit if rates were to fall. Once the agreed time period is over, the majority of fixed rate products will revert to the lender’s Standard Variable Rate (SVR).
• You have peace of mind knowing exactly how much your mortgage will cost.
• You have the security of knowing your payments will not rise if rates increase.
• The rate you start on tends to be higher than other products.
• If market rates fall, your payments will still stay the same.
• There are usually high penalty fees if you want to switch lenders within your fixed period.
• In most cases, you will not be able to make large overpayments
Variable rate mortgages
A variable rate mortgage can move up and down at any time, for a variety of reasons, however these mortgage products tend to be cheaper than fixed rates and offer greater flexibility. There are three types of variable rate mortgages to choose from: Standard Variable Rate’s (SVR), Tracker and Discount.
What is a tracker mortgage?
A tracker rate follows the movement of another rate. The rate most typically tracked is the Bank of England base rate, which is set independently by the Bank of England on a monthly basis. Each product will follow either above or below, at a set margin. The length of this product can last for anything from 2 years to the whole mortgage term. Once this agreed period is over you will revert to the lender’s SVR.
• If interest rates fall so will your monthly payments.
• These products often have lower rates and arrangement fees when compared to fixed rate mortgages.
• You may be able to secure a “lifetime” rate which often avoids the need to remortgage every couple of years, cutting the long term cost of your borrowing
• If interest rates rise so will your monthly payments.
• After your initial period you will be transferred to the lender’s SVR which might be considerably higher
What is a standard variable rate mortgage?
This type of product is the rate you revert to when your introductory period is over. Every lender has a Standard Variable Rate (SVR), which is a rate that they set independently. The rate can change at any time as lenders can choose to increase or decrease their SVR whenever they want, however its very rare for borrowers to be tied into this type of product, allowing the flexibility to make large overpayments, remortgage to another product or sell the property without incurring any penalties.
• If interest rates fall, it is usual for monthly payments to as well.
• Most SVR’s have no early repayment penalties.
• There is no guarantee that your payments will fall as lender’s can do as they wish.
• Interest rates can rise at any point
What is a discounted rate mortgage?
This product offers a discount off a SVR for a pre-agreed period of time (usually two to five years). Payments on your mortgage can still fluctuate as the lender can choose to alter their SVR at any time. However, the interest rate payable will always be reduced by the percentage agreed. The main draw into a discount rate is price. These products are amongst the cheapest in the market and the majority of them do not add an Early Repayment Charge (ERC), which means you can switch when you want without it costing a fee.
• If interest rates fall, your monthly payments will fall too.
• Lower monthly payments can help with the cost of moving.
• No ERC means you can easily remortgage without the costly fees.
• Your monthly payments could increase once your discounted period is over.
• There will always be uncertainty as the lender’s SVR can change at any time.
An offset mortgage combines your mortgage and savings in an incredibly cost effective and tax efficient way. When calculating the amount of interest payable on your mortgage, the lender effectively deducts the credit balance of your linked savings account, resulting in interest being charged only on the difference between the mortgage and credit balance. For example, if you have a mortgage of £200,000 and savings of £25,000, the lender will only charge interest on a £175,000 mortgage – a far lower sum.
Offset mortgages are offered on both fixed or variable rate products.
There are generally 2 outcomes from placing funds in an offset account:
1. Payment Reduction: the lender passes on the interest saving by reducing your monthly mortgage payment
2. Term Reduction: monthly mortgage payment stays the same irrespective of how much savings you have; the interest saving is effectively used as an overpayment resulting in you paying off the mortgage faster and therefore resulting in less interest being payable in the long term.
• You could pay off your mortgage quicker because you reduce the amount owed.
• You can still make withdrawals on your savings when you wish.
• As with a conventional savings account, your savings balances are protected under the Financial Services Compensation Scheme (FSCS) up to specified limits
• Because you aren’t “earning” interest; instead you’re simply cutting the interest payable on your mortgage, the interest saving is tax free
• You won’t earn any interest on the money in your offset account
• Some lenders charge a premium for these products