What are the different types of mortgages & which are best for first-time buyers?

What is a mortgage?

A mortgage is a long-term loan that you take out to buy property or land. Most mortgages are taken out over 25 years, but some are available over shorter and longer periods. The mortgage is secured against your home, so if you fail to keep up your repayments then your lender can repossess the property.

How does a mortgage work?

Let's say you want to buy a home for £200,000. Now let's assume you have £20,000 of savings to put down as a deposit. That means you will need a mortgage for the remaining £180,000 of the property's value. You borrow that capital from a lender - normally a bank or building society - and repay it over time, usually through fixed monthly instalments.

Your lender will charge interest on the mortgage, so you will end up paying back more than the £180,000 you borrowed in the first place. These interest payments are usually built into your monthly instalments. You can choose to repay both the capital and the interest, or you might decide you want to repay just the interest. These options are known as repayment mortgages and interest-only mortgages, respectively.

What is a repayment mortgage?

A repayment mortgage is where you pay off part of the money you've borrowed, plus the interest, each month. At the end of the full mortgage term, everything should have been paid off and you would own the home outright.

What is an interest-only mortgage?

As the name suggests, an interest-only mortgage means you only pay back the interest that is due on the loan, and not any of the capital. This means your monthly repayments will be significantly lower, but at the end of the mortgage term you'll still need to find a way to pay back the initial amount (£180,000 in the example used above).

What deposit do I need for a mortgage?

In many cases, you need to have at least a 10% deposit to secure a mortgage. However, thanks to the government's Help to Buy scheme, you could get one with just a 5% deposit. In that case, if the property you wanted to buy was valued at £200,000, you'd need to come up with £10,000 to put down up front.

If you have a larger deposit, lenders will see you as less of a risk and you'll gain access to better deals at lower interest rates. For example, having a 20% deposit will unlock cheaper mortgages and if you can jump into the next band - usually a 40% deposit - your deal will get even better.

What is a fixed-rate mortgage?

The same interest rate will be applied for the entire term of the mortgage, irrespective of whether rates rise or fall. With this type of mortgage, your monthly instalments will be the same each month, so you'll always know exactly how much is going out of your account. If you think interest rates are about to rise, a fixed-rate mortgage could be the way to go. If they fall, however, you won't benefit from that drop.

What happens when my fixed-rate mortgage ends?

When you take out a fixed-rate mortgage, you can usually fix the interest rate for a period of between two and five years. Once that time comes to an end, you can simply do nothing, which means you will be charged interest at the standard variable rate (SVR). The SVR is almost always higher than your fixed interest rate. The other option is to remortgage and fix the rate again for another few years, which is the more common choice taken by homeowners.

What is a variable rate mortgage?

The interest rate on this type of mortgage is not fixed and will rise and fall in line with the rest of the market. This means your instalments can change from one month to the next, so you need to make sure you have enough in your account to cover any fluctuations. The term ‘variable rate mortgages' covers a few different types: SVR, tracker and discount mortgages.

What is an SVR mortgage?

This is where lenders set their own SVR, which is not directly linked to the Bank of England base rate but is influenced by any changes to it. On an SVR mortgage, your repayments will move up or down depending on the changes applied by the lender, which can be done at any time. Some lenders will offer capped rate mortgages, which means the interest rates will not rise above a certain limit. With an SVR mortgage, you are free to find a new deal at any time.

What is a tracker mortgage?

Your interest rate will "track" the base rate of the Bank of England, plus a few per cent. So, if that base rate increases by 0.5%, so will the interest on your loan. These types of mortgages are usually fixed for between two and five years, but if you shop around you might be able to find a "lifetime" tracker mortgage that lasts the entire term.

What is a discount mortgage?

Choosing this type of mortgage means you will earn a discount on the lender's SVR. This discount is usually fixed for two or three years, and it makes sense to shop around for these deals. That's because some lenders will offer larger discounts but their SVR may be higher to begin with, so you need to work out which deal is going to offer the greatest saving overall.

What is an offset mortgage?

Offset mortgages allow you to use any savings to reduce the amount of interest you pay. Let's say you've taken out a mortgage of £150,000 but you have another £20,000 sat in your savings account. These savings help to offset your mortgage, so you're only paying off the interest on the difference, which in this example is £130,000. Of course, if you withdraw your savings then your mortgage is no longer offset.

What is a current account mortgage?

These types of mortgages are less common than they used to be. Here, your current account is rolled into one with the mortgage to give you one balance. So, if you had a mortgage of £100,000 and savings of £5,000, you would essentially be £95,000 overdrawn. You still make a regular repayment each month, and any extra credit in your account acts as an overpayment. You're likely to pay a higher interest rate on these types of mortgages simply because of the flexibility they give you.

What is a flexible mortgage?

A flexible mortgage deal will allow you to make overpayments and underpayments to the overall loan, usually a fixed percentage of the total in any calendar year, without being penalised.