Repayment or interest-only? Fixed rate or variable? When it comes to taking out a mortgage in the UK, you’ll soon find that there’s a wealth of options.
Even if you’re re-mortgaging your home for a second or third time, it’s still important to reassess your rate in relation to your current income and expenditures, to ensure that your loan repayments continue to be affordable in the short term and in the future.
So, if you’re buying for the first time or facing a mortgage rates renewal, here’s a look at some of the different options available, and what they mean for your monthly repayments.
Interest-only versus repayment mortgages UK
When you take out a mortgage in the UK you have a choice between a repayment mortgage or an interest-only mortgage.
Interest-only mortgage
An interest-only mortgage means you only pay the interest owed on the loan and not the loan itself. In other words, the amount you owe to your lender is never decreasing. At the end of the mortgage term (the number of years you’ve agreed to take out your mortgage for) you’ll be expected to repay the loan in full – at which point you may have to sell your home or risk having it repossessed if you don’t have the funds available.
Repayment mortgage
With a repayment mortgage, the payments you make to your lender each month go towards paying both the interest owed on your loan and reducing the mortgage debt. Providing you keep up with the repayments, your loan will be paid off in full by the end of the mortgage term, at which point you will own your home outright.
Interest rates on mortgages fall into two camps: fixed rate or variable rate:
-
Fixed rate mortgages
Fixed rate mortgages offer you a guaranteed rate of interest on your loan that stays the same for an agreed term (usually two, three, five, or ten years). This means that no matter if interest rates go up or come down, you’ll keep paying the same interest rate month-on-month, until your fixed rate period ends.
-
Variable rate mortgages
With a variable rate mortgage, the amount of interest you pay each month can vary. The rate isn’t secured, and you have no guarantees how high or low it will go, which means that you could pay more on your mortgage one month than another.
Types of variable rate mortgage UK
Variable rate mortgages offer you a flexible rate of interest that isn’t set in stone. This means that the amount you repay on your mortgage each month is also subject to change.
Examples of variable rate mortgage include:
Tracker mortgages
With a tracker mortgage, the interest rate typically tracks the Bank of England base rate – so if the Bank of England base rate rises, you your mortgage interest rate will too.
The amount you’ll repay on a tracker mortgage depends on the level of interest your lender imposes on top of the bank of interest bate rate.
As an example: if your tracker mortgage rate is ‘BOE base rate +1%’, the amount of interest you pay will be 1% higher than whatever the base rate is. This means that if the BOE base rate is at 5% you’ll pay 6% interest on your loan.
Where it differs is if mortgage rates come down. Tracker mortgages usually impose a lower-level cap that prevents your interest rate from dropping beneath a pre-determined threshold. This means that even if interest rates were to drop substantially, you might not fully benefit.
Standard variable rate (SVR)
A standard variable rate is a rate of interest determined by the lender, which – like a tracker mortgage – can go up or down each month.
Although STV rates don’t track the base rate in the same way as tracker mortgages do, many lenders will still take this into account when adjusting their rates. Your lender’s SVR is also the rate you’ll automatically default to after a fixed rate deal expires and is likely to be higher than the rate you had been paying – meaning your monthly repayments could increase.
Being on a standard variable rate does have its advantages, however. For one, you’re not locked in, so you’ll be free to re-mortgage without incurring a penalty. If interest rates were to drop significantly, you could also see your monthly repayments dramatically reduce.
Discount mortgage
With a discount mortgage, you benefit from a set discount on your lender’s standard variable rate. This rate of discount is fixed throughout the discounted product term, with the same percentage discount applied regardless of whether the SVR increases or decreases.
As with tracker mortgages, discount mortgages are only offered for a fixed term and the lender may also impose a cap to prevent the rate from falling too low.
Capped rate mortgage
Capped rate mortgages offer you a variable interest rate that is guaranteed not to rise beyond a certain threshold. That means that even if interest rates were to continually increase, your rate wouldn’t exceed the upper-level limit your lender has agreed to.
While this cap offers you a degree of certainty in terms of the maximum your mortgage payments could rise to, the flipside is that many capped rate mortgages also come with a ‘collar’ which prevents the rate from dropping beneath a certain level, preventing you from benefitting from low interest rate drops.
What is better fixed or variable rate mortgage?
The key difference between fixed rate mortgages versus variable rate mortgages is the certainty of knowing how much your mortgage payments will be each month. However, locking into a fixed rate also means you won’t benefit if mortgage rates come down – and you’ll be liable to pay a penalty if you repay your loan early.
Whenever you’re considering any type of mortgage rate it’s always a good idea to consult with a broker who can assess your finances and offer you some comparative projections based on different mortgage products. Make an appointment to speak to our mortgage advisers about your options.
Your home or property may be repossessed if you do not keep up repayments on your mortgage
Approved by The Openwork Partnership on 29/11/2023