Money Means guides are brought to you by FSCS, the people who protect your money from £1 up to £85,000 in UK banks, building societies and credit unions. Find out more.
Given that getting a home loan is one of the biggest financial commitments you are ever likely to make, it’s vital to understand which one is right for you.
The key thing to remember is while there are many products to choose from, certain products are better suited to certain types of borrower.
Here’s our guide to helping you navigate your way through the mortgage maze.
With a fixed-rate mortgage, you usually sign up to a deal for two, three or five years, although it is possible to sign up for as long as a decade. In return for this, the lender gives you a “special” rate, and this remains the same for the duration of the deal.
Pros: a fixed-rate mortgage gives you the peace of mind of knowing exactly how much your payments will be over a set period of time – making it easy to budget. Even if rates go up, your payments remain the same.
Cons: while fixed-rate mortgages provide the benefit of certainty, they tend to charge a premium over the initial rate charged by variable deals over the same period. You are also tied in for the length of the contract, and if you want to get out early, you will face a hefty penalty. With this in mind, think carefully about how long you want to sign up for.
With a tracker, the rate is variable, and usually linked to the Bank of England base rate. This means that if the base rate goes up, so will your mortgage. The base rate is announced by the Bank of England’s Monetary Policy Committee every month and can be found on the Bank of England’s website: http://www.bankofengland.co.uk/Pages/home.aspx
Trackers are particularly popular when interest rates are low or falling (as is the case now).
While there are no signs of the base rate going up from its historic low of 0.5 per cent any time soon, if it were to rise to 1 per cent, your mortgage would also go up by 0.5 per cent – thereby increasing your monthly repayment.
Generally speaking, trackers are available over two or five years, and, as with fixes, you will be charged a penalty if you want to get out early.
Pros: you may find that rates on the “best buy” tracker deals are lower than those on the top fixes. And while you don’t get the peace of mind that you do with a fix, you get the transparency of knowing exactly how your rate will change, as it is linked to the Bank of England base rate.
Cons: there is a lot more uncertainty with a tracker than with a fix. You need to be prepared for your monthly mortgage repayments to rise if rates rise – and must ensure you can still afford them if they do.
Standard Variable Rate
The Standard Variable Rate is the default rate you pay when the terms of your introductory deal – or discounted mortgage deal – come to an end. Lenders can move their Standard Variable Rate whenever they like. While this tends to roughly follow movements in the Bank of England base rate, this is not always the case.
Pros: in a low-interest environment (like the one we are in now), many borrowers benefit from falling rates and low monthly mortgage repayments, and choose to stay on their Standard Variable Rate. There is also usually no early repayment charge, meaning you can pay the home loan back in full at any time without penalty.
Cons: These rates can be considerably more expensive than other mortgage offers. There’s also no guarantee you will get the full benefit of all rate changes, as you are at the mercy of lenders hiking rates at their will.
An offset mortgage is a product which links your savings to your mortgage.
Rather than earning interest on your savings, the money is set against your outstanding home loan, so you pay less interest on that debt.
This type of deal is best-suited to higher-rate taxpayers and those with a decent sum in savings.
Pros: an offset is a good way to make your money work harder when savings rates are in the doldrums, and a great way to reduce the size of an outstanding mortgage. This will cut years off your mortgage term, and reduce the amount of interest you pay overall. An offset also offers flexibility as you can reduce the interest paid on your mortgage while still having instant access to your savings pot at any time.
Cons: an offset may not be the best option for lower-rate taxpayers and those with little squirreled away. Equally, the new personal savings allowance which came into place in April has also made offsets less useful, as savers can now earn £1,000 tax-free; some may find their savings are better kept elsewhere.
With a repayment mortgage, you will start repaying both the capital and the interest each month with your monthly mortgage payments; the capital is the amount you borrowed over the term of the loan.
Pros: you have the certainty of knowing your balance will be cleared at the end of the term.
Cons: the monthly repayments on a repayment mortgage will be higher than those on an interest-only mortgage.
With an interest-only deal, a borrower repays none of the capital, meaning the monthly payments only cover interest charges.You have to repay the capital once the mortgage term ends.
Pros: as you are only paying back the interest, monthly mortgage payments are lower than for a repayment mortgage. An interest-only mortgage offers a cheaper way to purchase a property.
Cons: as you are not actually paying back any capital, there is no certainty your balance will be cleared at the end of the term. If you don’t have a repayment strategy in place, and are relying on the sale of your home, you are taking a major risk. This is because if property prices fall, your debt will be bigger than your home’s value. For many, the best approach is to switch from interest-only to repayment as soon as possible.
The Money Advice Service has a handy calculator on its website to help people work out what their monthly payment might be.
What is Money Means?
Money Means is a news and information series written by independent financial and consumer journalists and experts. FSCS launched Money Means in 2016 to help give people clear and useful information about personal finance, to increase their understanding and confidence when dealing with money. Find more Money Means news here.