Buying a home is a huge milestone, but navigating the realm of mortgages can feel daunting, especially for first-time buyers in the UK. With an array of mortgage options available, understanding which type is best suited to your needs is essential.
The best mortgage type for you will be dependent on various personal and unique factors such as your risk appetite, financial objectives, current market conditions, qualifying criteria and more. So whilst we cannot provide specific tailored guidance without knowing more about your circumstances, this guide will give you an insight into many of the most common mortgage types available.
If you would like more personalised assistance after reading this guide, contact us today for tailored guidance and advice on your specific mortgage options.
1. Fixed-Rate Mortgages: Stability Amidst Uncertainty
Fixed-rate mortgages offer stability and predictability by locking in your interest rate for a set period, typically ranging from two to five years or even longer. This means your monthly repayments remain unchanged, providing peace of mind, even if interest rates rise during the fixed period. For example, if you secured a 5 year fixed-rate mortgage with monthly repayments of £800 per month, your monthly repayments would remain consistently fixed at £800 per month throughout the full 5 year period, regardless of fluctuations and interest rate changes in the broader market.
People Best Suited for This Type of Mortgage: Those seeking stability and predictability in their monthly repayments, especially in times of economic uncertainty. Borrowers who prefer to budget with certainty and value peace of mind.
People Least Suited for This Type of Mortgage: Borrowers who predict potential decreases in interest rates and want to take advantage of lower rates in the near future, even if it means paying more in the shorter term. In addition, those with intentions to retain their property for very short terms (e.g. property flippers and those who retain property ownership for shorter term periods).
Common Pitfall: Choosing a fixed term mortgage without taking into account your future plans and any applicable Early Repayment Charges (ERCs).
Avoidance Strategy: Assess your risk tolerance and financial goals to determine whether the stability of fixed-rate mortgages aligns with your preferences. Ensure you are fully aware of any ERCs and have a strategy in place to account for these, should you wish to remortgage, sell the property or switch lender sooner than the fixed term period ends.
2. Variable-Rate Mortgages: Flexibility in a Dynamic Market
Variable-rate mortgages offer flexibility as your interest rate fluctuates in response to changes in the Bank of England base rate or the lender’s standard variable rate (SVR). This can be advantageous if flexibility and shorter-term commitments are desired. Though in turbulent market conditions, it can expose you to the risk of your monthly repayments constantly rising in line with interest rate fluctuations.
Let’s say you opt for a variable-rate mortgage with an initial rate of 2% + the lenders Standard Variable Rate (‘SVR’). Assuming the SVR is set at 3%, this would make your effective mortgage interest rate 5% (2% + SVR of 3% = 5%). If the SVR increased from 3% to 4%, your mortgage rate would adjust to 6% (2% + new SVR of 4% = 6%). So with the added flexibility and lower commitment levels compared to a fixed term mortgage, there is also the added risk of being subject to interest rate fluctuations which can result in a lower monthly repayment (best case scenario) or a higher monthly repayment (worst case scenario).
Mind you, with a variable rate, depending on the specific type of variable rate and the terms of your mortgage, this can in the worst case scenario be uncapped. So for example, when interest rates rose significantly in line with inflation over the past few years, people with variable rate mortgages received regular periodic notices from their mortgage lenders informing them of the increased monthly repayment for their mortgage. So it is extremely important that you take proper risk planning precautions and planning before signing up for a variable rate mortgage.
People Best Suited for This Type of Mortgage: Borrowers who are comfortable with potential fluctuations in interest rates and want to take advantage of lower initial rates. Those with financial flexibility who can absorb potential increases in monthly repayments, with a solid risk planning and management strategy in place (and access to significantly more disposable income)). It may also suit those with shorter terms commitments to the subject property, depending on the more detailed circumstances and their objectives.
People Least Suited for This Type of Mortgage: Individuals who prefer stability and certainty in their monthly repayments. Borrowers who are concerned about potential increases in interest rates impacting their budget. Borrowers with less disposable income and those who cannot afford to absorb potential interest rate rises which result in larger monthly mortgage repayments being due.
Common Pitfall: Variable-rate mortgages expose you to the risk of rising interest rates, potentially leading to higher monthly repayments in the future. Some are not aware of this or don’t take proper planning precautions to account for this risk.
Avoidance Strategy: Consider your financial stability and ability to absorb potential fluctuations in interest rates before opting for a variable-rate mortgage. Assess your shorter term and longer term goals to decide on whether this is a mortgage type suited to your objectives and ability to manage risk.
3. Tracker Mortgages: Following the Market’s Lead
Tracker mortgages are linked to an external benchmark, typically the Bank of England base rate, plus a set margin. As the benchmark rate fluctuates, so does your mortgage rate, resulting in changes to your monthly repayments. For instance, if the tracker mortgage is set at the base rate + 1%, and the base rate is 2.5%, your mortgage rate would be 3.5%. If the base rate subsequently rises to 3%, your mortgage rate would adjust to 4%.
People Best Suited for This Type of Mortgage: Borrowers who want transparency and direct correlation to market movements. Those who believe interest rates will remain stable or decrease in the future.
People Least Suited for This Type of Mortgage: Individuals who are risk-averse and prefer the stability of fixed-rate mortgages. Borrowers who are concerned about potential increases in interest rates impacting their budget.
Common Pitfall: While tracker mortgages offer transparency and direct correlation to market movements, they also expose you to the risk of interest rate fluctuations.
Avoidance Strategy: Evaluate your risk tolerance and financial stability to determine whether the potential savings (if applicable) outweigh the uncertainty associated with tracker mortgages.
4. Discount Mortgages: Temporary Savings with a Catch
Discount mortgages offer an initial discount on the lender’s standard variable rate (SVR) for a set period, typically ranging from two to five years. This can lead to lower initial monthly repayments, making them an appealing option for budget-conscious buyers. For example, if the lender’s SVR is 4% and you secure a discount mortgage with a 1% discount for two years, your initial mortgage rate would be 3%. After the discount period ends, your rate would revert to the lender’s SVR at the time.
People Best Suited for This Type of Mortgage: Borrowers who are attracted to the Discounted Rate available and those who are also confident in their ability to budget for potential increases in monthly repayments should this apply.
People Least Suited for This Type of Mortgage: Individuals who prioritise long-term stability and prefer fixed-rate mortgages. Borrowers who are concerned about potential increases in monthly repayments impacting their budget.
Common Pitfall: While discount mortgages can sometimes offer short-term savings, they’re susceptible to fluctuations in the lender’s SVR, potentially leading to higher repayments at a later stage.
Avoidance Strategy: Carefully assess your budget and long-term financial outlook to ensure you can afford potential increases in monthly repayments.
5. Offset Mortgages: Maximising Your Savings Potential
Offset mortgages allow you to link your mortgage to a bank account with savings (usually with the same lender), offsetting the balance against your mortgage debt. For instance, if you have £20,000 in savings and a mortgage balance of £150,000, you would only pay interest on £130,000. This can lead to significant interest savings over the life of the mortgage, which can potentially shorten your mortgage term and speed up your ability to pay off the full balance.
People Best Suited for This Type of Mortgage: Borrowers with substantial savings who want to maximise their savings potential and reduce the overall interest paid on their mortgage. Those who value flexibility and prefer to keep their savings accessible rather than tie the same funds up in the mortgage, making it less accessible.
People Least Suited for This Type of Mortgage: Individuals with limited savings who may not benefit significantly from offsetting their mortgage with savings. Borrowers who prioritise maximising returns on their savings rather than reducing mortgage interest.
Common Pitfall: Offset mortgages may offer lower interest rates, but they often come with higher initial fees and require diligent financial management to maximise savings.
Avoidance Strategy: Assess your financial discipline and ability to maintain a healthy savings balance to determine whether offset mortgages are a viable option for you.
6. Shared Ownership Schemes: Opening Doors to Homeownership
For first-time buyers struggling to afford a property, government-backed schemes such as Shared Ownership offer a lifeline. This initiative provides financial assistance and flexibility, enabling buyers to step onto the property ladder with lower deposit requirements and shared ownership arrangements. For instance, Shared Ownership allows you to purchase a share of a property (usually between 10% and 75%) and pay rent on the remaining share. For example, if you purchase a 50% share of a property valued at £200,000, you would pay a mortgage on your share (£100,000) and rent on the remaining 50% (this of course doesn’t account for your deposit, so the real scenario would be that you would pay a mortgage on the amount of your share accounted for by your actual mortgage balance).
Over time, you can gradually increase how much of the property you own through a process known as “staircasing”. In simple terms, staircasing is the process of gradually buying a bigger percentage of the property over time, ultimately leading to full ownership of the property. This scheme offers an affordable entry point into homeownership, particularly for those with limited savings or income.
People Best Suited for This Type of Mortgage: First-time buyers with limited savings who need assistance with a deposit. Those who are open to shared ownership arrangements and want to gradually increase their ownership stake over time, rather than spend longer trying to save up a larger deposit for full ownership.
People Least Suited for This Type of Mortgage: Borrowers who can afford a traditional mortgage without government assistance. Individuals who prefer full ownership of their property and are not comfortable with shared ownership arrangements.
Common Pitfall: One common pitfall of Shared Ownership is the potential for limitations in property choice and resale value. Additionally, as you own only a portion of the property, you may encounter restrictions on making alterations or renovations without the consent of the housing association or landlord.
Avoidance Strategy: Before committing to Shared Ownership, thoroughly research the specific terms and conditions of the scheme, including any restrictions or obligations. Ensure you understand the process of “staircasing” to increase your ownership stake over time and assess the implications of fluctuations in property values on your investment.
