Mortgage types explained

Mortgages

Mortgage types explained

By Marie Kemplay

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Mortgage types explained

Find out about the different mortgage types and understand the pros and cons of fixed-rate mortgages, tracker mortgages and discount mortgages.

When you're choosing a mortgage, deciding which type of deal to go for is a key decision, so it's really important to understand how they work. 

After taking out your mortgage you'll pay an initial interest rate for a set period of time. This rate can be fixed (guaranteed not to change) or variable (may increase or decrease). Two, three and five-year deal periods are the most common. 

  • For expert, impartial advice on the best type of mortgage for your circumstances, call Which? Mortgage Advisers free on 0808 252 7987

Mortgage types

Below, you can find out how each mortgage type works, then you can compare the pros and cons of fixed-rate, tracker and discount mortgages in our table.

Variable-rate mortgages

There are two main types of variable-rate mortgage: tracker mortgages and discount mortgages.

Tracker mortgages 

With a tracker mortgage, your interest rate 'tracks' the Bank of England base rate (currently 0.25%) – for example, you might pay the base rate plus 3% (3.25%).

In the current mortgage market, you'd typically take out a tracker mortgage with an introductory-deal period. After this, you are moved on to your lender's standard variable rate. However, there are a small number of 'lifetime' trackers where your mortgage rate will track the Bank of England base rate for the entire mortgage term.

Find out more: Tracker mortgages

Discount mortgages

With a discount mortgage, you pay the lender's standard variable rate (a rate chosen by the lender that doesn't change very often), with a fixed amount discounted. For example, if your lender's standard variable rate was 4% and your mortgage came with a 1.5% discount, you'd pay 2.5%.

Discounted deals can be ‘stepped’; for example, you might take out a three-year deal but pay one rate for six months and then a higher rate for the remaining two-and-a-half years.

Some variable rates have a 'collar' – a rate below which they can’t fall – or are capped at a rate that they can’t go above. Make sure to look out for these features when choosing your deal to ensure you understand what you're signing up to. 

Find out more: Discount mortgages

Fixed-rate mortgages

With fixed-rate mortgages, you pay the same interest rate for the entire deal period, regardless of interest rate changes elsewhere.

Find out more: Fixed-rate mortgages

Standard variable rate mortgages 

Each lender has its own standard variable rate (SVR) that it can set at whatever level it wants – meaning that it's not directly linked to the Bank of England base rate. 

The average SVR in March 2016 was 4.81% according to Moneyfacts. This is higher than most mortgage deals currently on the market, so if you're currently on an SVR, it's worth shopping around for a new mortgage. 

Also, lenders can change their SVR at any time, so if you're currently on an SVR mortgage, your payments could potentially go up (it's unlikely a lender would decrease its SVR in the current mortgage market).

If you're still in the initial deal period of your mortgage, make a note of when it's due to end, and consider remortgaging at that point to avoid being moved on to your lender's SVR and paying more than you need to.

Find out more: Standard-variable-rate mortgages

Pros and cons of fixed-rate mortgages, tracker mortgages and discount mortgages

Understand the advantages and disadvantages of different mortgage types so you can choose the best product type for you.

Once you've weighed up your options, Which? Mortgage Advisers can advise on the best deal for your personal circumstances – call 0808 252 7987 for a free consultation.

Pros and cons of different mortgage types
  Pros Cons Average interest rate for this mortgage type
Fixed-rate mortgages

Pros of fixed-rate mortgages

  • During the deal period your repayments won't rise, even if interest rates do.
  • Ideal for those on a tight budget who want the stability of a fixed monthly payment.

Cons of fixed-rate mortgages

  • If interest rates in the mortgage market go down, you may end paying more than you would on a variable-rate deal.
2.81%
Tracker mortgages

Pros of tracker mortgages

  • If the base rate goes down, your monthly repayments will drop too (although this is unlikely to happen in the current market).
  • Your interest rate is only affected by changes in the Bank of England base rate, not changes to your lender's SVR.

Cons of tracker mortgages

  • You won't know for certain how much your repayments are going to be throughout the deal period.

 

2.23%
Discount mortgages

Pros of discount mortgages

  • Your rate will remain below your lender's SVR for the duration of the deal.
  • When SVRs are low, your discount mortgage could have a very cheap rate of interest.

Cons of discount mortgages

  • Your lender could change their SVR at any time, so your repayments could become more expensive.

 

 

 

2.80%

*Average rate data from Moneyfacts based on all mortgage products of that type available 1 November 2016

Whether you should choose a fixed or variable-rate deal depends on whether you think your income is likely to change, whether you prefer to know exactly what you will be paying each month and whether you could cope if your monthly payments went up.

Find out more: Should I get a fixed rate mortgage?

Interest-only and repayment mortgages 

With an interest-only mortgage, you just pay interest on your mortgage, while with a repayment mortgage, you also pay off the the money you borrowed. 

Interest-only mortgage repayments will be cheaper, but you will not have paid off any of the capital at the end of your mortgage term.

It is very unusual to get an interest-only mortgage in the current mortgage market.

Find out more: Interest-only vs repayment mortgages

Mortgage features to look out for

Flexible mortgages

Flexible mortgages let you over and underpay, take payment holidays and make lump-sum withdrawals. This means you could pay your mortgage off early and save on interest.

You don't normally have to have a special mortgage to overpay, though; many 'normal' deals will also allow you to pay off extra, up to a certain amount – typically up to 10% each year.

Other types of flexible mortgages include offset mortgages, where your savings are used to offset the amount of your mortgage you pay interest on each month. 

Alternatively, current account mortgages combine your current account, savings and mortgage into one, so all your credit balances offset your mortgage debt.

Flexible deals can be more expensive than conventional ones, so make sure you will actually use their features before taking one out.

Cash back mortgages 

Some mortgage deals give you cash back when you take them out.

But while the costs of moving can make a wad of cash sound extremely appealing, these deals aren't always the cheapest once you've factored in fees and interest. Make sure you take the total cost into account before choosing a deal. 

  • Last updated: September 2016
  • Updated by: Marie Kemplay

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