What are mortgage types, and how to choose the right one

A mortgage is a loan that you take out from a bank or a lender to get your foot on the property ladder. There are several types of mortgages and each one of them has their own pros and cons. Mortgage terms are bewildering because they are sub-categorised into fixed, variable and interest-only mortgages.

What is a fixed-rate mortgage?

A fixed-rate mortgage, as the name suggests, is a mortgage that enables you to pay down a sum of money at a fixed interest rate. The monthly size of instalments will remain the same throughout the fixed interest-rate period. It is worth noting that no mortgage is available at a fixed interest rate throughout their lifetime. Fixed interest-period deals last for up to two, three or five years depending on the policy of the lender.

Once the fixed interest-period deal expires, you will be put on a variable interest rate. Standard variable interest rates vary by lender. They keep changing throughout the mortgage payment term. As the base rate goes up, the variable interest rate would also go up and vice-versa.

As long as you are on a fixed-rate mortgage deal, you can easily plan around your budget. As you know that how much amount of money you have to pay every month, you can set aside that much money beforehand in order to avoid falling behind on payments.

Here are the pros and cons of fixed-rate mortgages:

One of the benefits of a fixed-rate mortgage is that you will be paying a consistent amount of money every month. This is particularly beneficial when the base rate by the Bank of England goes up. However, on the flip side, you will not see any reduction in the size of the monthly instalments if the base rate by the Bank of England drops.

A fixed interest rate mortgage is generally aimed at making people comfortable with their mortgage payments in the beginning.

What is a variable interest-rate mortgage?

Having said this earlier, a variable-interest-rate mortgage is subject to fluctuating interest rates. Every month you will be paying down a different sum of money. This is because interest rates are decided based on the base rate by the Bank of England.

There are four types of variable mortgages. One of them is the standard variable. The other three include tracker mortgages, discount mortgages, and capped-rate mortgages. Tracker mortgages and standard variable mortgages are both the same, with the only difference being that the interest rate for the latter keeps fluctuating at the discretion of the bank.

In other words, tracker mortgage payments keep going up and down as the base rate by the Bank of England goes up and down. The interest rate you are charged entirely depends on external factors. However, standard variable interest rates do not necessarily go down even if the base rate drops. It depends on the bank how much the interest rate will change.

Likewise, discount mortgages and capped-rate mortgages are also variable-rate mortgages. Discount mortgages offer lower interest rates than standard variable mortgages only for a specific period of time. The discounted period is available for up to two to five years. For instance, if the standard variable interest rate is 5% and you have got a discount of up to 1% for two years, you will be paying down your mortgage at 4% interest for two years, and then onwards, you will be charged 5%.

Capped-interest mortgages, on the other hand, provide you with protection against the maximum rate of interest.

What are interest-only mortgages?

Interest-only mortgages require you to pay down a very small amount of money every month. This includes only interest payments. Interest-only mortgages are quite expensive because the whole loan amount is repaid at the end of the loan term. The only benefit of an interest-only mortgage is that you will have flexible payments. As you will pay down only interest, you will not feel a burden on your pocket.

But the flip side of this mortgage is that you will end up with negative equity because the whole amount would have to be paid down at the end of the term. To avoid bearing the impact of economic challenges, it is always suggested that you have a robust strategy to settle your mortgage.

Interest-only mortgages are not ideal for every kind of borrower. You should consider interest-only mortgages only when you are expecting to sell or refinance your house soon. Further, they are ideal for those borrowers who are on a tight budget and are confident about their repaying capacity at the end of the loan term.

Buy-to-let mortgages

Buy-to-let mortgages are not the same as regular mortgages. They are aimed at those who are looking to buy a house in order to buy it. Buy-to-let mortgages carry higher interest rates than standard mortgages. You are required to pay only interest every month.

However, remember that you will have to arrange a bigger deposit size for a buy-to-let mortgage. While standard mortgages require you to have at least a 10% deposit, buy-to-let mortgages require you to have at least a 20% deposit.

In case you are looking for bad credit mortgage loans with guaranteed approval, you will have to arrange an even bigger deposit. For a standard mortgage, you need at least a 20% deposit, while for a buy-to-let mortgage, you will make it up to 40%.

Choosing the right mortgage

Once you have decided which mortgage you need, you need to take the following two steps:

• First off, you should assess your financial situation. Are you completely certain that you would be able to repay the debt on time? Sole proprietor mortgages, for example, could be risky because your financial condition may not be stable.
• Compare mortgage deals. Every lender has their own criteria to decide interest rates. You should carefully examine what you will be charged so you do not end up with an expensive deal.

The final word

There are several types of mortgages, and each mortgage has its own pros and cons. You should carefully assess your financial condition while taking out a mortgage.