Demystifying Mortgages: The Most Common Types Of Mortgages Explained

Buying a home is a significant milestone and likely the most expensive purchase you’ll ever make. Most homeowners in the UK take out a mortgage to buy their home, but understanding mortgages can be daunting. You have a myriad of options available, and those options are often not explained as clearly as they should be. But we can help with that.


Here we’ll clearly and simply explain what mortgages are, and what the differences are between the most common types of mortgage. We’ll also answer the most commonly asked questions about mortgages, from what happens if you miss a mortgage repayment to how an interest only mortgage works.


Before we go into detail on the various different types of mortgage available to you, here we’ll briefly explain how mortgages work.


Mortgages are usually provided by banks and building societies. Once you’ve been approved for a mortgage and you’ve bought your new house, you’ll have to start paying it back. You’ll pay back your mortgage with monthly instalments – this covers the money you borrowed (called the principal) plus an amount of interest. For most mortgages, you’ll pay these monthly instalments for 25 years, but some mortgages last longer, with 35-year mortgages becoming increasingly common.


Mortgages are secured loans, meaning your property is the collateral for the loan - the asset the loan is based on. If you can no longer afford to pay back your mortgage, the building society or bank can repossess your property to sell it to recover their money.


Now that the basics of mortgages are covered, here we explain the main types of mortgage that will be available to you:



1. What is a fixed-rate mortgage?


With a fixed-rate mortgage, you’ll make repayments with a fixed interest rate for a certain amount of time, usually from two to five years. There are longer options available though, fixed rate mortgages can be found for three, seven, 10, and 15-year terms.


At the end of the fixed-rate term, you'll have to remortgage, with most lenders opting for another fixed-rate mortgage term. If you don’t remortgage, you’ll be moved to the bank or building society’s standard variable rate (SVR), which is usually more expensive (a higher rate of interest).


Fixed-rate mortgages are the most common type of mortgage in the UK as they give you stability and predictability. You’ll repay the same amount each month during your fixed-rate term no matter what happens to interest rates in the wider economy. This stability lets you plan your finances with confidence.



2. What is a tracker mortgage?


Unlike a fixed-rate mortgage, with a tracker mortgage the interest rate on your mortgage can change, meaning your monthly payments can vary.


The interest rates of tracker mortgages are based on the Bank of England base rate (the Bank of England’s interest rate). Usually this is the Bank of England base rate plus a given amount, like 1%. This means if the Bank of England base rate is 4%, your mortgage interest rate would be 5% (4% + 1%).


If the Bank of England base rate falls or rises, the interest rate on your mortgage will follow (track) it. If you have a Bank of England base rate plus 1% mortgage, and the base rate falls from 4% to 3%, your mortgage interest rate would fall from 5% to 4%. If the base rate rises from 4% to 5%, your mortgage interest rate would rise from 5% to 6%.


Some tracker mortgages come with a 'collar’ or ‘floor'. This is a lower rate that your mortgage interest rate can never fall below. So even if the Bank of England base rate plunges, your mortgage interest rate won’t track it all the way down. For example, you might have a Bank of England base rate plus 1% mortgage with a 2% collar. If the base rate falls to 0.5%, your mortgage interest rate won’t fall to 1.5%, it’ll remain at 2%.


Most tracker mortgages are offered with an introductory period, usually for two years. Once this period is reached, you’ll have to remortgage or you’ll be moved to the lender’s standard variable rate (SVR) mortgage.


Tracker mortgages offer the potential for lower interest rates, but you’ll need to be prepared for the possibility of rises in your monthly payments. Tracker mortgages are an option to consider if you don’t need the stability of fixed payments and you expect the Bank of England base rate to fall in the near future.



3. What is a variable-rate mortgage?


Variable-rate mortgages, also called adjustable-rate mortgages (ARMs), are like tracker mortgages where the interest rate you pay on your mortgage can rise or fall. However, rather than tracking the Bank of England base rate, variable-rate mortgages usually track a different underlying interest rate, typically the lender’s standard-variable-rate (SVR).


Whilst the lender’s SVR is based on the Bank of England’s base rate, the lender can raise or lower their SVR at their own discretion. The lender's SVR may not move exactly in line with the Bank of England base rate.


Like tracker mortgages, variable-rate mortgages are typically offered with a two-year introductory period. After two years, you’ll have to remortgage or you’ll be moved to the lender’s standard variable rate (SVR) mortgage.


Just as with tracker mortgages, variable-rate mortgages are suitable for people who can cope with rises in monthly mortgage payments as well as falls, and who predict that interest rates will be lowered in the near future. Unlike tracker mortgages, your interest rate won’t track the Bank of England base rate, but another rate, like your lender’s SVR.



4. What is an interest-only mortgage?


With an interest-only mortgage, you only pay the interest on your mortgage for a set period of time, usually the first few years of your mortgage term. For example, if you borrow £300,000 for 25 years with a 5% interest rate for a three year interest-only period, then for those three years you won’t repay any of the £300,000 borrowed, you’ll just pay the 5% interest in monthly payments.


After the initial interest-only period, you’ll typically have to remortgage to a fixed-rate mortgage, tracker mortgage, or variable-rate mortgage. This means you’ll start to repay both the interest and the money borrowed (the principal).


Some interest-only mortgages last longer though. And if you opt for one of these, you’ll need to have a plan in place to help you repay the mortgage principal at the end of the interest-free term. Usually this is a separate investment scheme, like an Individual Savings Account (ISA), a pension, or an investment portfolio. With this option you run the risk that your investments won’t have earned enough money to repay the principal when it’s due.


Interest-only mortgages offer you lower monthly payments during the interest-only period, making home ownership more affordable in the short term, as the initial payments are lower.


However, whilst interest-only mortgages provide temporary relief on monthly payments, they may end up costing you more in the long run, due to the delayed repayment of the principal.


If you’re considering an interest-only mortgage, you need to have a solid plan for how you will repay the principal when the interest-only period ends.



5. What is a standard-variable-rate (SVR) mortgage?


You can think of a standard-variable-rate (SVR) mortgage almost like a default mortgage. When you’re approved for a mortgage – whether that’s a fixed-rate mortgage, tracker mortgage, or variable-rate mortgage – you’ll usually be offered an introductory period or fixed-rate term that lasts from two to five years. After this period, you’ll have to remortgage. If you don’t, you’ll be moved to the lender’s SVR mortgage.


The standard-variable-rate (SVR) is the bank or building society’s own internal standard interest rate. It’s based on the Bank of England base rate, but the lender can choose to move it at their discretion, so it won’t follow the Bank of England’s base rate exactly.


With an SVR mortgage, your monthly payments could vary, either increasing or decreasing as the lender’s SVR changes. SVR mortgages tend to have higher interest rates than fixed-rate mortgages, tracker mortgages, or variable-rate mortgages, so you should always try to remortgage to avoid a SVR mortgage, if you can.


The mortgages we’ve described so far are the most common ones you’ll encounter when you begin to think about and research mortgages. However, there are lots of other mortgages out there, although these are often versions of the ones we’ve mentioned above. You may also read or be told about:


Bad credit mortgages: Intended for those who’ve had financial difficulties in the past and don’t have a good enough credit rating for a standard mortgage. Bad credit mortgages are often offered by specialist lenders.


Commercial mortgages: Allow you to buy a property for your business.


Discount mortgages: A type of variable-rate mortgage that offers a discount on the lender’s standard variable rate (SVR), such as SVR minus 2%. So if the lender’s SVR is 5%, you’d pay 3% interest.


Guarantor mortgages: A family member or a friend who won’t be living with you agrees to act as a guarantor, meaning they’ll repay your mortgage if you can no longer meet your monthly payments. Guarantor mortgages can help you get on the property ladder if you have a low income, with the help and support of someone else.


Help to Buy mortgages: Allow first-time buyers to apply for a mortgage with only a 5% deposit. The government then provides a loan, called an equity loan, of up to 20% of the mortgage (up to 40% in London or 15% in Scotland). You then borrow the rest of the money needed from a bank or building society as a mortgage.


Right to Buy mortgages: A government scheme that allows you buy your council house at a substantial discount if you're a council tenant


Self-employed mortgages: Mortgages for those who run their own business.


There are lots of different mortgages out there, and we know how complicated mortgages can be. But the first step is to better understand your options, and we hope this simple guide has helped with that.


A good second step is to consider whether you want a mortgage with a fixed interest rate or whether you want one with a variable rate. You should also consider what your unique circumstances are, and whether a more specialised type of mortgage will be more appropriate for you, like a Help to Buy mortgage or a self-employed mortgage.


And remember, you don’t have to go it alone when it comes to mortgages. We recommend speaking to a mortgage advisor or broker, or a financial advisor, to benefit from their knowledge and experience. They can help you better understand your options and which mortgage types are most suitable for you.


Finding the right home can be complicated. But as well as helping you better understand mortgages, we can also help you find your ideal new build house. Discover our selection of newly built houses for sale across the UK and get in touch with us to find out more.


The most frequently asked questions about mortgages:


What is a mortgage?


A mortgage is a loan you get from a building society or bank to buy a property.



What’s the difference between a loan and a mortgage?


A mortgage is one type of loan. Whilst you can take out loans for many reasons, a mortgage is a type of loan specifically intended to help you buy a property.



What is a mortgage deposit?


A mortgage deposit is a lump sum of money you pay upfront to the bank or building society that lends you your mortgage when buying a home. The larger your deposit, the less money you’ll have to borrow.



How much of a mortgage deposit do I need to buy a house?


This will vary by mortgage lender, but most require you to have at least a 10% deposit, meaning your deposit is as much as 10% of the price of the house (if you’re buying a house for £200,000, you’d need a £20,000 deposit). The average mortgage deposit for first time buyers is closer to 15%, however a Help to Buy mortgage can help you get a mortgage with only a 5% deposit.



Where can I get a mortgage?


Mortgages are offered by finance companies, with most mortgages in the UK provided by banks or building societies. To get a mortgage, you can either approach banks or building societies directly, or you can approach an independent financial adviser or a mortgage broker. The latter are experts in mortgages – they can help you compare a large number of them and they may have access to exclusive deals.



How much will my monthly mortgage repayments be?


With most mortgages, you’ll need to pay them back over a period of 25 years in monthly payments. Each monthly payment will usually consist of both a repayment of the principal (the amount of money you borrowed) and the interest you’re paying on that principal. The amount you pay back each month will depend on how much you borrowed, the length of your mortgage, and your mortgage interest rate.



What happens if I miss a mortgage repayment?


If you miss a mortgage repayment your lender may charge you a late payment fee. The missed payment will likely be reported to the credit reference agencies, and this could harm your credit score. If you continue to miss repayments, and you can no longer afford to pay your mortgage back, your lender will eventually repossess your property to sell it so the lender can recover their money.


If you think you won’t be able to pay a monthly repayment, speak to your lender as quickly as possible. Explain your situation and they’ll work with you to find a solution to help get you back on track.



What's the difference between a tracker mortgage and a variable-rate mortgage?


With a variable mortgage, the lender can set and change their own variable interest rate. However, a tracker mortgage follows the Bank of England base rate, which your lender doesn’t control.



How does an interest-only mortgage work?


With an interest only-mortgage, you only pay back the interest on the money you borrowed (the principal), rather than the principal itself. However, at the end of the interest-only period, you’ll have to repay the principal, so you’ll need to have a plan in place to do so.



What is remortgaging

Remortgaging means moving your mortgage to a new deal with the same lender or to another lender. Lots of mortgages are given with an introductory period or with a fixed-rate period, usually between two to five years. You’ll have to remortgage after this period ends to get a good deal on your mortgage, or you’ll usually be moved to the lender’s more expensive standard variable rate (SVR) mortgage.