Different types of mortgages

Hands up if you can afford to buy a house outright. Probably not a huge show of hands, because not everyone has that amount of money lying around. That’s why mortgages exist. Let’s take a closer look at what they are and the different types you can get.

A mortgage is likely to be the biggest financial commitment you will ever make. That’s why it’s so important that your mortgage is right for you. Do the research, make sure you know how this fits with your finances and your lifestyle. And if there’s any uncertainty, make sure you seek advice.

What is a mortgage?

A mortgage is a loan you borrow from a lender (like us), to pay for a house. You pay a bit back every month over an agreed period of time, usually around 25 years, but it can be more or less. The amount you can borrow will be based on how much money you have coming in and going out every month, and your ability to make the monthly repayments.

The deposit

Lenders will usually ask you to pay a deposit up front before they'll consider you for a mortgage. For example, if a property is worth £125,000 and the lender wants a 20% deposit, you’ll need to save £25,000 of your own money beforehand.

Interest on your mortgage

Not all mortgages are the same, but they all have one thing in common – the lender will charge you interest on the money you borrow – that means there’s your mortgage, then interest on top.

The higher the mortgage rate, the more you’ll pay in interest. Generally, the quicker you pay off your mortgage, the less interest you’ll have to pay overall.

Repaying your mortgage

There are three main payment types.

1. Repayment (sometimes called 'capital and interest')

Your monthly repayments go towards repaying the mortgage and the interest, so they will be higher than they would be with an interest-only arrangement. However, overall you’ll pay less interest because your debt reduces every month. You might even be able to switch to a better deal a few years down the line because you’ll have lowered your debt, plus, you won’t have to worry about paying a large lump sum at the end of the term.

2. Interest only

Your monthly mortgage payments only repay the interest and don’t go towards repaying the original amount borrowed so your mortgage loan won’t reduce over the years. The upside is that you’ll have lower monthly repayments, which could free-up some cash for things like home improvements.

But – before you apply, you’ll need to have a good financial plan in place to repay the entire mortgage by the end of the term.

You could also sell the property at the end of the term to repay the lender, but there’s no guarantee its value will be enough to cover the outstanding debt. If you are planning on selling your property, be aware that some lenders may not accept this as part of your repayment plan.

3. A combination of the interest-only and repayment (part and part)

You can have a mortgage that’s part interest-only and part repayment, which means you can split it between the two repayment types. You’ll need to have a financial plan in place to repay the interest-only portion, which will be owed at the end of the term.

Types of mortgage

Fixed rate

Fixed rate means the interest rate is fixed on your mortgage for an agreed period of time – usually for two, three, five, seven or ten years. So your interest rate won’t change even if external interest rates go up or down.

Fixed rate mortgages can be useful if you’re budgeting and want to know exactly what your payments will be each month. You might pay slightly higher rates compared to other types of mortgage, and you might have to pay an arrangement fee. Usually, at the end of the fixed rate period, your lender will automatically transfer your mortgage to a variable rate.

Usually, with a Skipton fixed rate mortgage you can overpay up to 10% of your original loan amount every year without having to pay an Early Repayment Charge, during the initial fixed term. But, if you want to repay in full or move your mortgage while it’s still in the fixed-rate period, you might need to pay the Early Repayment Charge.

Variable rate

Your monthly repayments can go up or down with a variable rate mortgage because of changes to your interest rate. Rate changes can happen for a variety of reasons - some will be decided by your lender, others might be driven by what’s happening in the economy.

Variable rate tracker

You might come across a type of variable rate mortgage called a ‘tracker’. It’s called a tracker because it ‘tracks’ an independent rate, such as the Bank of England base rate, for a set period of time. So if the independent rate rises, the interest you pay on your mortgage will rise too. If the independent rate decreases, the interest on your mortgage will decrease too.

Trackers can be good when the independent base rate is low, because your monthly mortgage repayments will be less. But if your tracker doesn’t have a cap and the base rate increases, your payments will rise up too. Some trackers have a cap, so you’ll know the maximum you’ll ever have to pay, and others have ‘floors’ that stop rates falling too low, which means you might not benefit if rates fall really low.

Standard variable rate (SVR)

This type of interest rate can fluctuate, but unlike the tracker, changes to the SVR are driven by the lender, not an independent base rate.

On the upside, mortgages on SVR often don’t have Early Repayment Charges, so if you find yourself in a position to repay your mortgage earlier than planned, you might not be charged.