When is comes to mortgages, there is more to consider than just how much it costs each month. You also need to think about the type of deal you want both now and in the future, as well as the risks and benefits that come with each option. Below you will find a broad breakdown of many of the options available to you, but it is easiest to think of mortgages as being broadly categorised as one of two types: fixed or variable.
With a fixed rate mortgage, you gain the peace of mind of knowing exactly where you stand for a predetermined period of time – typically between 2 and 5 years, although other options do exist in the constantly changing world of mortgage products. Your interest rate and mortgage payment will not change within that period of time, meaning you know exactly where you stand.
The benefits of this include the ability to budget your outgoings and not have to worry about the risks of interest rate increases. However, you will typically pay more for a fixed rate than a variable rate, effectively paying a premium to remove the risk of rate increases, and should rates fall you will not receive the benefits. It is also worth remembering that you will typically be tied in to a fixed rate and could face a penalty should you want to get out of the deal early.
These can be a subset of fixed rate mortgages or variable rate mortgages, depending on the individual product. With a stepped rate mortgage, you typically have a very low rate for an initial period, and then at a predetermined time in the future the rate will increase for a further period.
The benefits of a stepped rate mortgage are that they give you a lower monthly payment initially, which can help if you need to keep payments down in the early days of your mortgage while, for example, you need money for making improvements to the property. You should not face any surprises as you will know exactly when the rate will increase and by how much. The main drawbacks of stepped rates are that they are typically more expensive overall than their non-stepped equivalents.
The key point to consider with variable rates is that the interest rate, and therefore your monthly payment, can increase at any time. Therefore, you need to know that you can afford to pay considerably more than the initial monthly payment. However, they can of course go down, meaning your monthly payment could fall as well. There are many subsets of variable rates, some of which are covered below.
Tracker rates typically track the Bank of England base rate by a specified margin either for a specific period of time, for example a 2-year tracker, or sometimes for the life of the mortgage. The benefits of tracker rate mortgages are that they are typically the cheapest type of rate available, meaning your payments may be considerably lower initially and, should the rate which they track come down, so will your mortgage payments. The main drawback is the risk of the rate increasing and therefore your monthly payments increasing as well, and there is no limit to how high they could go.
This is a variable rate which can go up or down as and when the lender decides, typically moving when the Bank of England base rate changes. The benefits to this type of rate are that you usually will not be tied in, meaning you have the flexibility to overpay and leave without cost any time you choose.
Most short-term deals like fixed rates will revert to a standard variable rate when the fixed deal expires and the actual interest rate will vary from lender to lender. The main drawback to a standard variable rate mortgage is that they are typically a higher rate than you would otherwise pay, effectively paying a premium for the flexibility that comes with them.
Discount rates refer to a discount from the lender’s standard variable rate and these deals typically last for a couple of years, reverting back to the standard variable rate at the end of the deal. The benefits of these deals are that they are cheaper than the standard variable rate. However, they can go up as well as down, similarly to the standard variable rate that they track. These deals also typically come with exit fees should you wish to repay the mortgage during the discount period.
These are typically either discount rates or tracker rates that give all of the advantages of those rates. However they come with a cap in terms of how high the rate can go. This gives some security as you know your monthly payment will not go beyond a certain level, however you would typically expect that these will be more expensive than their uncapped equivalents.