Whether you are a first-time buyer, an experienced homeowner or someone who is thinking about investing in property, understanding the various mortgage options is key in helping you make an informed decision.

Mortgages are an important aspect of owning your own home, helping individuals to turn their dreams of being a homeowner into reality.

The world of mortgages can seem overwhelming, with an array of jargon, terms and conditions and choices to decipher. Worry not, here we will break down the basics of mortgages and explore the main types that are available in the market. By the end, we hope that you'll have a clear understanding of the options you can consider, and you will feel empowered to make the right financial choice for your and your needs.

What is a Mortgage?

Before we delve into the types of mortgage, let's look at what a mortgage is.

In simple terms, a mortgage is a loan that is specifically designed for purchasing a property. It allows an individual to borrow money from a lender (usually a bank or building society), to finance buying a home. The borrower will repay the loan over an agreed period, normally over several years, through regular mortgage repayments which will cover both the amount borrowed and the interest.

To determine the loan terms (including the interest rate, repayment period, and any additional conditions), the mortgage lender will review various factors including the borrower's income, credit history and the value of the property.

Types of Mortgages

1. Fixed-Rate Mortgages: With a fixed-rate mortgage, the interest will remain the same for a set time period, usually two, three, five or even 10 years. This type of mortgage can offer stability as repayments are going to be the same each month and borrowers are also shielded from fluctuations in interest rates. However, it does also mean that if the Bank of England base rate drops, your interest rate will remain the same.

2. Variable Rate Mortgages: Unlike fixed-rate mortgages, these mortgage types have an interest rate that may fluctuate over time. There are two main types of variable-rate mortgages: a) Tracker Mortgages: These are directly tied to a set benchmark, normally the Bank of England's base rate. The interest rate on the mortgage will adjust in line with any base rate changes, meaning that your monthly repayment can increase or decrease as a result of fluctuations in the base rate. a) Standard Variable Rate (SVR) Mortgages: These mortgages are set by the lender and can vary independently of the base rate. As lenders are able to adjust the interest rates, even if the base rate remains stable, borrowers may experience changes in their monthly repayments. You may find that if you have previously been on a fixed, tracker or discount mortgage, that you are automatically transferred onto a SVR at the end of the agreed term, unless you decide to move to another fixed or tracker mortgage.

3. Discounted Rate Mortgages: These mortgages offer a reduction on the lender's standard variable rate for a set period. With these mortgage types, borrowers are initially provided with lower monthly repayments, but typically revert to the lender's SVR once the discount period ends.

4. Offset Mortgages: With this type of mortgage, the borrower's savings or current account balance is linked to the mortgage. By savings being offset against the outstanding mortgage balance, borrowers may effectively reduce the amount on which interest is paid. This can lead to savings being made on interest payments, and potentially a shorter mortgage term.

Mortgage Repayment Options

When considering mortgage options, it is important to under the difference between repayment and interest-only mortgages, as these options will determine how the loan is paid off.

Repayment Mortgages

A repayment mortgage (sometimes referred to as a capital and interest mortgage), is the most common type of mortgage in the UK. With a repayment mortgage, the monthly repayments that you make cover both the capital (the original amount borrowed) and the interest charged on the loan. As you make regular repayments, over time, the outstanding loan balance decreases.

How Does it Work?

• Each month, a portion of your payment goes towards repaying the capital, reducing the amount owed

• The remainder of the payment covers the interest that is charged on the outstanding balance

• The loan balance will gradually decrease as you keep making these repayments, until it is fully repaid by the end of the mortgage term

Advantages of Repayment Mortgages

• As the monthly payment contribute to both the interest and the capital, you are on a path to become mortgage free

• The outstanding debt decrease over time, resulting in a build of equity in the property

• At the end of the mortgage term, the loan will be fully paid off and the property will be yours

Interest-Only Mortgages

With an interest-only mortgage, your monthly repayments only cover the interest charge on the loan. You will not be making any contributions towards repaying the capital that was borrowed, and the loan amount will remain unchanged throughout the mortgage term.

How Does it Work?

• Every month, based on the outstanding balance, you pay only the interest of the loan

• At the end of the mortgage term, you are responsible for repaying the original loan amount in full

It is important to note that lenders will usually require you to have a repayment plan in place to make sure that you repay the capital once the mortgage term comes to an end. This may involve making regular contributions to an investment vehicle, for example to an Individual Savings Account (ISA), or through other means, such as using savings or selling a property.

Advantages of Interest-Only Mortgages

• Lower monthly payments: as you will only be repaying the interest, and not repaying any of the capital, monthly payments will be lower in comparison to a repayment mortgage

• Potential flexibility: In the short term, interest-only mortgage may provide more flexibility, enabling you to allocate your funds towards other financial goals

Potential Risks of Interest-Only Mortgages

• Repaying the capital: You will need to ensure that you are able to repay the capital at the end of the mortgage term.

• Investment risk: If you are planning to use investments to repay the capital, the performance of these may impact your ability to repay the loan

• Limited build up of equity: The outstanding loan amount remains the same with an interest-only mortgage and the equity in your property will not increase through regular repayments

Interest-only mortgages have become less common over the years, and lender generally have stricter borrower criteria in place for this type of mortgage. Before making a decision, make sure that your fully understand your options, the risks and repayment plans associated with interest-only mortgages by discussing with a qualified mortgage advisor.

Understanding the different types of mortgages available in the UK is essential for anyone starting their journey to owning their own home. Each type of mortgage caters to different financial goals and circumstances, offering unique features, benefits and terms. Ultimately, the choice between mortgage types and repayment options depends on your financial circumstances, preferences, and long-term goals.

Editorial Disclaimer: This article was updated 09.07.2023.

Opinions expressed here are the author's alone, and not those of any bank, credit card issuer or any other company. This article has not been reviewed, approved or otherwise endorsed by any of these organisations.

NB: The information on this page does not constitute financial advice, please do your own research to ensure that the product / service is right for your individual circumstances.