Understanding the Different Types of Mortgages in the UK: The Pro's and Cons

Embarking on the journey of buying a home in the UK can be thrilling yet daunting, especially when it comes to choosing the right mortgage. With several options available, each catering to different needs and financial situations, making an informed decision is crucial. This guide delves into the various mortgage types, their pros and cons, and identifies the ideal customer for each, helping you navigate your path to homeownership with confidence.

We would recommend you seek the services of a Mortgage advisor either through your bank or an independent who can discuss your bespoke set of needs to ensure you select the right type for your circumstances or future aspirations.

Fixed-Rate Mortgages: The Safe Harbour

A fixed-rate mortgage locks your interest rate for a predetermined period, ensuring your monthly payments remain unchanged. These are incredibly popular as the fixed rate gives a lot of certainty on the repayment amount. However these periods are usually on fixed for a period of 1-5 years with the longer the period the higher the rate.

For example a bank may have a head line offer of a 4% fixed mortgage which may be an attractive rate when compared to standard variable rate. This is however only fixed for 2 years and if you wanted to fix you rate for 5 years the bank may offer a higher rate of 4.5% to offset their risk of base rate moves in the future. Also watch out for product fee's which are a sneaky way of banks charging for setting up the mortgage and actually may offset any wins they offer on a lower rate.

One the fixed period is over the interest will change to a standard variable rate and you are able to set up a new fixed rate deal.

Pros:

• Predictability in budgeting.

• Immunity to interest rate increases in the market.

Cons:

• Typically higher initial rates than variable types.

• Penalties for early repayment.

Ideal for: Those seeking stability in their monthly outgoings, especially useful for first-time buyers or individuals on a strict budget who cannot afford any surprises.

Standard Variable Rate (SVR) Mortgages: The Default Option

Standard Variable Rate Mortgages sometimes shortened to the acronym SVR are the default mortgage type you're moved onto after your initial mortgage deal ends, with the rate set by the lender and subject to change.

This will be set by the lender and usually is based on the current Bank of England rate plus a mark up, not completely unlike a tracker mortgage. These usually don't have repayment penalties so you are free to go and seek new deals in the market or you can overpay your mortgage without penalty if you don't wish to be locked in again to a minimum term.

Pros:

• Flexibility to overpay or switch without early repayment charges.

• Possible rate decreases if the lender lowers their SVR.

Cons:

• Unpredictable monthly payments.

• Generally higher rates compared to other deals on the market.

Ideal for: Borrowers looking for flexibility and those planning to switch to a better deal shortly after their initial mortgage term ends.

Tracker Mortgages: Following the Market

Tracker mortgages are directly linked to the Bank of England's base rate, meaning your interest rate will move in line with changes to the base rate. This can be massively beneficial in times where rates are dropping and before the financial crash of 2008 some lucky customers had deals tracking at a rate below the base rate.

This meant when the base rate dropped to 0.5% some customers found themselves in positions where the mortgage actually had zero interest and in some crazy rare cases the bank actually owed interest to the mortgage holder. Since this banks have learned from this event and Tracker rates are now set a higher mark up that previously so the bank will always keep a healthy rate of interest being accrued on the mortgage.

However if we are entering a period where the base rate starts to increase like 2023 which saw continue increases it can mean constantly increasing repayment amounts which can feel like a rising tide each month. There is definitely some risk in tracker mortgages.

Pros:

• Direct benefits from any decreases in the base rate.

• Transparency in how rates are determined.

Cons:

• Risk of payment increases if the base rate goes up.

• Early repayment charges may apply.

Ideal for: Financially flexible individuals who can afford higher payments during rate increases and wish to take advantage of potential decreases.

Interest-Only Mortgages: The Investment Play

An Interest Only Mortgage is where the borrower only pays the interest each month, with the capital due at the end of the mortgage term, resulting in lower payments but the loan never being paid back until a separate capital payment is made.

This is great for property investors who want to keep mortgage payments as low as possible to maximise their net yields. This strategy works best when you expect the value of house prices to increase creating equity in the property and you can be in a position to fully repay the mortgage in one lump sum when you sell the investment.

Failure to properly plan your investment strategy can result in negative equity if house prices fall and you have not been reducing the capital amount of the mortgage.

Pros:

• Significantly lower monthly payments.

• Flexibility to invest surplus income elsewhere.

Cons:

• The need to repay the capital in a lump sum.

• Reliance on having a solid repayment strategy.

Ideal for: High-earners with significant investments or those with a credible plan to accumulate the necessary capital over time.

Buy-to-Let Mortgages: For the Property Investors

Buy to Let Mortgages are specifically designed for properties that will be rented out, these mortgages are assessed on rental income potential rather than the borrower's income.

This type is very popular with private landlords and property investors who can purchase properties at a lower value, spend money on renovation then re-mortgage to unlock property equity. This type works best when rental income on a property is more than the mortgage payments creating a net income for the landlord.

Pros:

• Potential for rental income to cover mortgage payments and generate profit.

• Opportunity for capital growth over time.

Cons:

• Higher interest rates and down payment requirements.

• Dependence on rental income to meet mortgage obligations.

Ideal for: Investors looking to enter the property market or expand their portfolio, with a focus on long-term capital and income growth.

Government-Supported Schemes: The Helping Hand

Description: Initiatives like Help to Buy, Shared Ownership, or the Lifetime ISA offer financial assistance or leverage to first-time buyers and those struggling to save for a deposit. due to increasing properties prices and a shortage in new affordable houses, it has become difficult for first time buyers to get onto the property ladder.

In order to keep the housing market moving the Government intervenes in the form of schemes designed to help new buyers into the marker and onto the ladder. This keeps the market moving and allows sellers to then themselves move up the ladder and unlock the next level of properties and so forth.

These schemes can change with different governments or even different chancellor's so its worth checking out the government website or a mortgage advisor.

Pros:

• Access to property with a lower deposit.

• Support for individuals unable to afford a home independently.

Cons:

• Limited to specific properties and eligibility criteria.

• Potential for complicated exit strategies with Shared Ownership.

Ideal for: First-time buyers and those with limited savings for a deposit, looking for an entry point into the housing market with governmental support.

Conclusion

The UK mortgage market offers a variety of options to suit different needs, from the stability of fixed-rate mortgages to the investment potential of buy-to-let options. By understanding the pros and cons of each type and considering your financial situation and homeownership goals, you can make a more informed decision. Always consult with a mortgage advisor to tailor your choice to your unique circumstances, ensuring a smoother journey to securing your dream home.