Which mortgage type suits you best?
Some deals will tie you up for two years, others for as long as five, while some don't tie you up at all.
Read our guide to make sure you get the best deal for you.
Should you go for a fixed or variable-rate deal?
Fixed rate: Your monthly repayments will not change, even if there is a change in interest rates. Repayments are only fixed for a specific period, typically two, three or five years, after which you will either remortgage onto another deal or be switched onto your lender's standard variable rate (SVR).
Pros: Fixed rates provide peace of mind – if interest rates rise, your loan repayments won't go up, making it easier to budget.
Cons: Peace of mind comes at a price – fixed mortgage rates will typically cost more than the best variable rates and while you are protected from rate rises, you won't get the benefit of falling interest rates.
Discounted variable rate: Here the initial rate will be a discount on the lender's SVR for a set period of time. After this, it will revert to the SVR. Rates are set by the lender and are not directly pegged to changes in the official interest rate (the Bank of England Base Rate).
Pros: Discounted rates are likely to be lower than fixed rates.
Cons: You are not protected from interest rate rises, and, because rates are set by the lender, you may not get the full benefit of interest rate falls – indeed rates could change even if interest rates have not moved at all.
Tracker: Unlike some variable-rate deals, where rate changes are at the lender's discretion, trackers charge a fixed percentage around bank base rate.
Pros: Transparency. Rates are pegged to the official rate of interest meaning lenders have to pass on the full benefit of rate cuts, and cannot increase your repayments by more than any increase in base rate. You can also be sure that your lender won't increase rates even if interest rates don't change.
Cons: You aren't protected from interest rate rises.
Moneywise verdict: If you want the certainty that your rates will not go up it makes sense to go for a fixed rate.
However, you need to bear in mind that rates at outset will usually be lower on a good variable rate so if you can cope with rising interest rates you may prefer to go with the very cheapest rate you can get and take your chances. Your decision will be very much led by your view on interest rates and your attitude to risk.
If rate rises are small and gradual you could be better off with a cheaper variable rate over the long term, but if rates rise fast you may be pleased you fixed. Take a look at the difference between the best fixed and variable rates and consider how many rate rises it would take for the fix to become the cheaper option – the wider the gap, the bigger the premium you are paying to fix. However, if the gap is very narrow you may decide it's a price worth paying. It's also worth noting that fixed-rate mortgages anticipate interest rate rises so prices start rising well before an increase in base rate.
How long a deal should you take?
While you might be taking out a mortgage with a 25-year term, your deal – which determines the rate you'll pay over a given period of time – will typically only last for two, three or five years. After then, you'll be switched onto the lender's more expensive standard variable rate or you can remortgage to a better deal with the same lender or a new one. The only deals that tend to be offered for the life of the loan are tracker rates.
Moneywise verdict: What length of deal you should go for depends on your personal circumstances. Many deals – particularly if you go for a fix – will have early repayment changes so you need to be sure you won't need to redeem the mortgage in that time.
This is the advantage of shorter-term deals – they don't tie you down for too long and make life easier if you don't plan to stay in your current home. Another plus is that they are usually the cheapest option too. However, if you are able to commit to a five-year deal you can forget about your mortgage for a while and remortgage less frequently – which can be an expensive process in itself, with some application fees exceeding £2,000.
Offset mortgages: This type of loan allows you to link your mortgage to your savings to reduce the level of interest you pay. So, if you have a £100,000 mortgage and £20,000 in savings you only pay interest on £80,000 of debt.
Offset mortgages are very flexible: you can overpay, you can underpay (so long as you have previously overpaid) and you can still access your savings whenever you like. You can choose to enjoy lower monthly payments now or pay more to clear your mortgage faster.
As you are offsetting your savings against your mortgage you no longer earn any interest on them, however this could be a sacrifice you don't mind making. Take the example of a borrower with £200,000 mortgage and £20,000 in savings. Over 25 years they could save £38,000 in interest or knock two years and eight months off their mortgage according to figures from Yorkshire Building Society.
Pros: Offset mortgages are very flexible and enable you to either reduce payments or pay off your loan faster
Cons: Although the price differential is narrowing, they are typically more expensive than standard loans. Not all lenders sell offset mortgages, so choice is also more limited.
Moneywise verdict: Offset mortgages can be a very savvy way of whittling down your mortgage, but because they are typically more expensive than standard loans you need a sizeable amount of savings to make them worthwhile. Experts suggest you need between 10 and 20% of your outstanding mortgage.
They are particularly tax-efficient for higher-rate taxpayers who would otherwise lose 40% of savings interest to tax (unless it was held in a tax-protected Isa). If you don't have a large amount to offset – you may be better off with the cheapest deal you can find and making ad hoc overpayments as and when you can afford it.
Do you go for repayment or interest only?
Repayment: With this type of mortgage your repayments cover capital and interest so that you own your property outright by the end of your mortgage term.
Pros: So long as you keep up repayments you own your home by the end of the mortgage term.
Cons: Monthly repayments are higher than interest-only loans.
Interest only: These deals allow you to only repay the interest on your loan, meaning your monthly repayments are lower. So if you want to keep the property once you reach the end of the mortgage term you need to have a repayment plan in place to ensure you can pay off your loan. Before the financial crisis, this type of loan was hugely popular, particularly for cash-strapped first-time buyers, but due to the risks involved they are becoming much harder to come by.
To qualify you will need a large deposit and prove that you have a repayment plan in place. Additionally, you may no longer be able to borrow any more than you would have been able to borrow with a repayment loan, removing much of its appeal.
Pros: Monthly repayments are lower because you are not paying off capital. They were useful for anyone with a realistic chance of coming into large sums of money in the near future, such as a salary rise or inheritance, who could then use the cash to pay off the mortgage early – saving a small fortune on interest over the years. Buy-to-let mortgages are also usually arranged on an interest-only basis and landlords often aim to earn a decent rental yield on the property's value and/or profit from an increased selling price in the future rather than own the property outright.
Cons: Unless you plan to sell the property at the end of the mortgage term you will need a repayment plan to ensure you can pay off the capital. This carries the risk that your investment will fail to reach your target and leave you with a mortgage shortfall.
Moneywise verdict: If you are buying a home that you wish to remain in after you've repaid your mortgage, it almost always makes sense to choose capital repayment.
Go for interest only and there is a risk that you will not have enough money to repay your loan – meaning you'll have to raid your savings or sell up to pay it off. Interest-only loans, however, can make sense for landlords with buy-to-let mortgages.
They can enjoy lower monthly repayments and sell the property at the end of the term to repay the loan, taking any increase in its value as profit. Although it is now much harder to get a new interest-only loan for residential property buyers, existing borrowers should still be able to remortgage but lenders are encouraging - and supporting - them to switch to a repayment deal.
What if I want to overpay my mortgage?
Most mortgages will now allow you to overpay 10% of your mortgage without penalty every year. Your mortgage is a great home for any windfall you might receive, be it a bonus or inheritance, as it will speed up repayment of your mortgage and reduce the amount of interest you pay. Some lenders might allow up to 20% a year so this is important aspect of a mortgage deal to check first.
An unexpected one-off financial gain in cash or shares, generally when mutual building societies convert to stock market-quoted banks. Also windfall tax, a one-off tax imposed by government. The UK government applied such a measure in the Budget of July 1997 on the profits of privatised utilities companies.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
Every mortgage lender has a standard variable rate of interest, or SVR, on which it bases all its mortgage deals, including fixed and discounted rate and tracker mortgages. When special deals come to an end, the terms of the deal usually state that the borrower has to pay the lender’s SVR for a period of time or pay redemption penalties. The lender’s SVR is, in turn, based on the Bank of England’s base lending rate decided by the Bank’s Monetary Policy Committee (MPC). Every time the MPC raises its rate, mortgage lenders generally increase their SVR by the same amount but when the MPC lowers its rate, lenders are often slow to pass this on or don’t pass on the full cut to borrowers.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.