Types of mortgage

With an ‘interest-only’ mortgage you only pay the monthly interest charged on your loan. As a consequence, you are not actually reducing the amount of the loan itself and you will need to ensure you have a realistic strategy in place to repay the loan at the end of the mortgage term. This might include a savings or investment account that you pay into monthly for example, and your mortgage lender will want to see proof that you have some sort of savings or investment account set up.

You must also remember that few savings and investment products are guaranteed to repay your mortgage in full because the value of investments can go down as well as up. If your savings or investments don’t cover the full amount of your loan once your mortgage term is up, you will be responsible for paying the difference. Otherwise, you could have your home repossessed.

With a ‘repayment’ mortgage your monthly payments actually reduce the amount you owe as well as paying the interest that your lender charges. Therefore, each month you are paying off a small part of your mortgage. Over time your mortgage amount will reduce and – provided you maintain the required repayments – it will be repaid in full at the end of the term without you needing to make extra provisions.

This tends to be the default for mortgages. The interest rate you are charged on your mortgage loan changes according to market interest rates such as the Bank of England’s base rate. Your monthly repayments can go up and down – if the Bank of England raises its base rate for example, then your mortgage rate will go up and vice versa. You should be comfortable if interest rates do rise. A standard variable is not necessarily the most competitive rate available.

As the name suggests, a fixed rate mortgage means your monthly payment will stay the same for a set period – irrespective of whether the market rate (such as the Bank of England base rate) goes up or down. The fixed rate period is typically between two and five years.

At the end of this period, your lender will usually change your interest rate to their standard variable rate. As you know exactly what you are paying every month until the end of this period, it makes budgeting easier and is often appealing to first time buyers that want some security. The cons are that you don’t benefit if interest rates fall. Plus, you may need to pay an early repayment charge (or other charges) if you want to change mortgage provider or you choose to pay your mortgage off early.

Some mortgages start with an initial interest rate that is lower (discounted) than the standard variable rate for a set period of time. It means you pay slightly less in the first few years, when money may be tight.

As a discount rate is likely to vary with market rates such as the Bank of England’s base rate, your monthly payments could go up or down – which can make budgeting difficult. You must be confident that you can afford the repayments when the discount ends, as your lender will change the interest rate to the standard variable rate (see above).

With a tracker rate, your mortgage interest rate is directly linked to market rates such as the Bank of England’s base rate. A tracker rate can mean accessing lower mortgage rates than you would get with a fixed rate mortgage, but your payments could rise (or fall).

The idea of an offset mortgage is that it links the savings in your main current and/or savings account to your mortgage debt (usually assuming they are held with the same provider).

As your savings go up, your mortgage interest payments come down and vice versa. You won’t earn interest on your savings in the linked accounts.

If you don’t have much saved in a linked savings account then an offset mortgage might not be worthwhile, as the mortgage interest rate is often higher than those on other mortgage interest rate options.

With a capped rate mortgage your mortgage interest rate is linked to your lender’s standard variable rate (see above), but it provides a guarantee that it won’t go above a set level (known as the ‘cap’) for a period of time.

This way, you know the maximum amount you will pay over a set period of time, making it easier to budget.

The cap generally lasts for between two to five years and then the mortgage will revert to the lender’s standard variable rate (or tracker rate) for the rest of the term.