Different types of mortgages

Capital repayment and interest-only mortgages

Capital repayment mortgage

With a capital repayment mortgage, you pay off the interest and a proportion of the loan you took out.

This is the most common mortgage repayment plan, and means you will own your property outright when you've repaid your mortgage.

Interest-only mortgage

With an interest only mortgage, you only pay off the interest owed each month. You don't repay the loan amount you borrowed until the end of the full mortgage term.

This means your mortgage payments will be lower, but that you will need a large lump sum to pay off the ‘capital’ or original loan amount at the end of the term. Lenders will require to see evidence of this repayment plan before offering a mortgage.

Buy-to-let mortgages are commonly offered on an interest-only basis. This is because landlords are usually happy to sell the property at the end of the term to cover the cost of the loan.

However, interest-only mortgages are rarely offered for residential properties now, due to them being far riskier for the borrower and lender.

Fixed-rate vs variable-rate mortgages

Fixed-rate mortgage

With a fixed rate mortgage, your interest rate is fixed at a certain level for a set period of time.

This means you don’t have to worry about your repayments going up if the Bank of England base rate increases or your mortgage provider raises its standard variable rate (SVR).

However, it also means you could end up losing out if interest rates fall, as a fixed rate is locked in for the duration of the deal. You’ll usually have to pay early repayment charges (ERCs) to switch away within that time.

Two-year fixed-rate mortgage

A two-year fixed-rate mortgage means your interest rate is fixed for two years. This is one of the most common fixed deal periods.

At the end of the two year period, you will be moved on to your lender's standard variable rate (SVR), which is usually higher so it's normally better to remortgage to a better rate.

A two-year fix can be beneficial if you want peace of mind that your rate will stay the same, but also don't want to be locked in for too long in case rates decrease.

Five-year fixed-rate mortgage

Five-year fixed-rate mortgages are also fairly common. The longer deal period allows peace of mind that your rate will remain the same for longer.

However, you are also locked into that rate for longer and will likely have to pay significant early repayment fees if you

10-year fixed-rate mortgage

While not as common as two-year and five-year fixes, there are a number of 10-year fixed-rate mortgages on the market.

They are ideal for those who want to know that they won't be surprised by an interest rate increase for the next decade.

But they also lock you in that rate for a long time, which isn't ideal if rates fall during that time.

Also, if you expect to move home within the next ten years, it's worth checking if you can port it to a new property. Otherwise you may need to pay significant ERCs when you do.

Variable rate mortgage

With a variable rate mortgage, the interest rate you pay can fluctuate. The three types of variable mortgage are:

• Standard variable rate (SVR) mortgage

• Tracker mortgage

• Discount mortgage
  

Standard variable rate mortgage

When you come to the end of your fixed or variable deal period, you're moved to your lender's SVR which is usually higher than other deals on the market.

It's normally best to remortgage at this point to secure a lower rate.

But there are some advantages to being on an SVR, including no ERCs. Sometimes it can make sense to remain on it for a short period of time, for example if you're moving soon.

SVRs often change if the Bank of England base rate moves. According to recent mortgage statistics, the average SVR for UK mortgage borrowers exceeded 5% in July 2022 (the first time this has happened in 13 years.)

Tracker mortgage

A tracker rate mortgage is another kind of variable rate mortgage that tracks the Bank of England base rate as it moves up and down.

You might, for example, take out a tracker mortgage that charges interest at the base rate plus 1%, so if the base rate is 0.1%*, your rate is 1.1%. 

* for demonstration purposes only, the current UK base rate is 5.25%.

Discount mortgage

A discount mortgage has a rate which is discounted from the mortgage lender’s SVR for a certain time, say two or five years.

If the SVR goes up or down during that time, the discounted rate will rise or fall in line with the change. 

For example, if the SVR is 7%, your discount rate might be 4%. But if the SVR increases to 8%, your rate will increase to 5%.

Buy-to-let mortgages

A buy-to-let mortgage is used to purchase a property to rent out. They work very similarly to residential mortgages, with a few key differences:

• A higher deposit amount is required, usually 25% (but this can vary between 20 and 40%)

• The borrowing amount is based on the estimated rental income, rather than your salary

• They are often taken out on an interest-only basis

If you choose to purchase your buy-to-let property via a limited company, you will need to get a limited company buy-to-let mortgage. According to the latest buy-to-let statistics, more than 83,000 buy-to-let mortgages were approved in 2023, and that number is only expected to rise.

Other types of mortgages

Offset mortgages

With an offset mortgage, you can use ‘offset’ your savings against the amount you owe on your mortgage. So if you have £30,000 in savings, and you owe £280,000 on your mortgage, your offset mortgage payments will be calculated as if you owed £250,000.

An offset mortgage can be a good option if you have a lot of savings, but are unwilling to use them to pay down your mortgage because you want access to them if necessary.

However, the interest rate you earn on your money in an offset mortgage account might not be as good as putting your money in a regular savings account and overpaying your mortgage.

If you plan to overpay on your mortgage, it’s worth comparing the returns you could get via a savings account with the savings you can get from an offset mortgage.

Guarantor mortgages

Most mortgages require a deposit of around 5% to 20% of the property’s value, but some people, particularly first-time buyers, may struggle to save this. While quite rare, there are options that allow you to purchase a home with no deposit.

With a guarantor mortgage, a friend or family member can guarantee to make your mortgage repayments if you cannot. But this does put both of you at financial risk if you fail to keep up with the repayments.

Family offset and deposit mortgages

Family offset and deposit products are alternative options which may also allow you to get a 100% mortgage. These require a family member to put their savings into an account held by the lender as a deposit.

The savings will either gain interest or offset your mortgage interest, depending on the option you go for.

Flexible mortgages

Flexible mortgages offer more flexibility around repaying the loan, including how and when you do.

This can be useful if you want to repay part of the loan early at any stage. However, different deals offer different degrees of flexibility so check the terms and conditions to be sure it will work for you.

Joint mortgages

A joint mortgage allows multiple people to take out a loan to buy a property together.

Commonly used by couples to purchase a home, this means you are both taking on the financial risk associated with taking out a mortgage.

Help to buy mortgages

The government-backed Help to Buy Equity Loan scheme in England ended in March 2023, but applicants in Wales are still able to apply. It is also not available in Scotland or Northern Ireland.

It aims to help first time buyers with a low deposit get onto the housing ladder. If, for example, you only have a 5% deposit, you can borrow up to 20% of the cost of your home from the government, then take out a mortgage for the remainder. 

Shared ownership mortgages

There’s also a shared ownership scheme for new builds or properties being sold on by housing associations.

With it, you can buy a 25% to 75% share in the property and pay rent on the rest.

You can then increase your equity share of the property in a process known as 'staircasing'. It’s only open to households that earn £80,000 or less a year (or £90,000 or less in London).