UPDATE: Since this article was published, we have created a section on all the financial aspects of buying your new home, including the different types of mortgage, which you can find here.
Applying for a mortgage is most people’s first step towards securing a new home. There are many types of home loan available, which is why you’ll need to weigh up the options before deciding which is most suitable for you.
A mortgage advisor is the best person to guide you through the process of finding a mortgage, but here are some of the products available and what you’ll need to think about before making a decision.
Interest-only or repayment mortgage?
Your first decision is whether to apply for an interest-only or repayment mortgage. The type you choose will impact how you pay off your home loan.
• Interest-only mortgage
An interest-only mortgage means you’ll only pay off the interest charged on your loan. You won’t be repaying any of the capital in your home, so you might need to save money elsewhere to make sure you can eventually pay back what you borrowed.
• Repayment mortgage
With a repayment mortgage, you will pay off some of the loan and its interest every month. This type of home loan is also known as a ‘capital and interest mortgage’.
A repayment mortgage helps guarantee you will have paid off the entire loan by the time it reaches the end of its term. It can also make you eligible for more competitive deals when your current product comes to an end.
The different types of mortgage
Now it’s time to think about which type of mortgage is right for you. There are five different products you’re likely to come across.
• Fixed rate
A fixed rate mortgage is exactly what the name suggests – the amount you pay will stay the same throughout the term of the home loan. Most people choose a fixed rate mortgage if they want to guarantee how much they are spending on repayments each month. However, bear in mind if interest rates fall, your repayments won’t.
Mortgage Bureau’s Lee Cardwell, an independent mortgage advisor to Strata customers, explains that fixed-rate home loans are especially popular at the moment.
“People are expecting interest rates to increase, so they are fixing while rates are good,” Lee says.
“Most fixed-rate products last two to five years, although many first-time buyers are going for five-year loans because they are using the Help to Buy scheme.”
• Variable rate
Another type of mortgage to consider is a variable rate product, which means the interest rate can change throughout the term of your loan.
The main advantage is that if interest rates fall, so will your mortgage repayments. However, a rise in interest rates could mean you end up paying out more each month.
• Tracker rate
Tracker mortgages move in line with the Bank of England base rate, which is set every month. If the base rate rises or falls, the interest on your tracker mortgage will do the same.
• Standard variable rate (SVR)
Your mortgage lender will have a standard variable rate product – this is the normal rate of interest they’d usually charge on a home loan. You’re likely to end up with a SVR mortgage once the term of your current home loan comes to an end, as it will automatically revert to a SVR unless you’ve chosen another product.
Once again, your interest rate will be determined by the Bank of England’s base rate. One of the main advantages of this type of mortgage is you can to switch to another product at any time.
Lenders might also offer a discount mortgage, where a reduced interest rate is charged on their SVR product.
The length of the deal will be determined by your lender and once it comes to an end, it’s likely your home loan will revert back to the SVR.
Weigh up fees and charges
Fees and charges apply to some mortgages, which you’ll need to factor into your monthly budget when buying a new home.
If you choose to use a mortgage broker, they are likely to charge a set fee for their services, or a percentage of the amount you borrow from a lender. Check how much you will be expected to pay before enlisting their help. You won’t need to pay anything if you use one of our panel of recommended mortgage advisors.
One of the most common charges you’re likely to come across is an arrangement fee. You can usually either add this to the term of your mortgage – increasing your monthly payments – or pay it upfront.
Doing your calculations is essential if you’re offered a mortgage that comes with charges and fees, and others that aren’t. Your independent mortgage advisor will be able to discuss the options and help you work out how much each home loan will cost you in the long run.