Which type of mortgage should I choose?

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If you’re thinking of taking your first step onto the property ladder, just hearing the word ‘mortgage’ may fill you with dread.

But since buying a home is probably the largest purchase you will ever make, it is vital you understand the different types of mortgage available.

Mortgage Advice Bureau have put together this handy guide that explains the jargon and will help make buying your first home as simple as possible.

The type of mortgage you are able to apply for will vary according to a number of factors, and hinge on whether you want an interest only or a repayment mortgage:

Mortgage types

Repayment mortgages

This means you pay the interest and part of the capital off every month, so that at the end of the mortgage term you should have paid it all off and own your home outright. In the earlier years of your mortgage, the majority of your monthly payments comprise interest. But towards the latter part of the term, this situation is reversed so that you’re paying off larger chunks of the amount borrowed.

Interest only mortgages

This means that you pay only the interest on the loan and none of the capital - which is the amount you borrowed in the first place. These days, this type of mortgage is much more difficult to come by as since the 2008 financial crash, lenders are worried about homeowners being left with huge debt and no way of repaying it.

Fixed rate mortgages

If you take out this type of mortgage, the interest you pay will stay the same throughout the length of the deal, even if the Bank of England changes interest rates. Usually set over periods of two to five years, this type of mortgage can provide peace of mind that your monthly payments will not increase.

Variable rate mortgages

With this type of mortgage, the interest rate can change at any time, so it is wise to have some savings put aside so that you can afford to increase your payments if necessary. Variable rate mortgages are more difficult to understand because they come in various forms, which we have outlined below.

Mortgage rates

Standard Variable Rates (SVR)

This is the normal interest rate a mortgage lender will charge and it will last as long as your mortgage does, or until you take out another deal. With this type of rate, your payments will rise and fall depending on the Bank of England’s interest rate changes. However, they won’t necessarily change at the same time or by the same amount.

Discount Variable Rates

This allows you to benefit from a discount on the lender’s standard variable rate – basically, if the lender’s SVR increases or decreases, so does the discounted rate. The advantage of this is that if the lender cuts its SVR, you will pay less each month. But on the flip side, it can cause a problem when it comes to budgeting because the lender is free to raise its SVR at any time. Furthermore, if the Bank of England rates rise, you could see the discount rate increase too.

Tracker mortgages

This type of mortgage usually moves directly in line with the Bank of England’s base rate, plus a few per cent. These types of mortgages usually have a short life, but some lenders offer trackers that last the life of the mortgage or until you switch to another deal.

Capped rates

With this type of mortgage, the rate moves in line with the lender’s SVR, but the cap means the rate cannot rise above a certain level. This delivers a degree of certainty as you know your rate will not rise above the cap, but it is important to work out whether you can afford the repayments if the rate does rise to the level of the cap.

Offset mortgages

This kind of mortgage usually works by linking your savings account, current account or both to your mortgage so that you only pay interest on the difference. You still have to repay your mortgage every month, but your savings act as a kind of overpayment that helps you to clear your mortgage early. Offset mortgages can either be on fixed or variable rates.

Mortgage Advice Bureau offers face-to face and telephone advice to customers across the UK through a network of 750 advisors. To find out more, visit our website.