There are many different mortgage options available. You can choose a repayment mortgage or interest only; and if you go for interest only there are a range of different investments you can use to pay off the loan. And then there are discounted-rate mortgages, cashbacks and fixed rates over differing time periods (e.g., fixed for a year).
We’ve provided a reminder of how each type works, together with a note of its main pros and cons. Just select the area that interests you from the menu below.
1) Interest Rate Options
Click on the following topics to read more about the pros and cons: Variable Discounted Fixed Capped
or click here to use our "what sort of mortgage suits me" calculator.
The simplest form of loan is one which sets its interest rate according to the lender’s standard variable rate, or SVR. With a loan like this, your interest payments are likely to rise or fall every time there is a change in the Bank of England's base rate.
Good Points: there are usually no early redemption penalties on these loans.
Bad points: the unpredictability of interest rate movements makes it hard to plan your finances, and the costs of your mortgage may rise rapidly if interest rates go up. Click here to use our calculators to assess the affects of different interest rates on your repayments.
Also, lenders don’t always pass on the full change in base rate (sometimes this can be to your advantage, but often not)
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Discount Rate Mortgage
These loans help reduce your expenses in the early years by setting your interest rate at a few points below the lender’s Standard Variable Rate (SVR). Your interest payments may still move up and down, but the differential between your rate and SVR remains constant.
Good points: the discount helps to free money for other expenses, such as new furniture or redecoration just when you need it most.
Bad points: when the discount period comes to an end, the loan's shift back to SVR which may mean a big leap in what you pay. Some of these loans also carry early redemption penalties which will reduce their benefit if you move early on. Our site clearly shows you how much the redemption penalties will be for a particular mortgage if you redeem it early.
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Fixed Rate Mortgage
Loans like this fix your interest payments at a specified level for the first few years. When the fixed-rate period has expired, your payments change to match the lender's standard variable rate (SVR).
Good points: the fact that you know exactly what your mortgage will cost you in the early years helps with household budgeting.
Bad points: these loans sometimes carry early redemption penalties which persist long after the fix is over. This can leave you trapped with an uncompetitive SVR loan. Our site clearly shows you how much the redemption penalties will be for a particular mortgage if you redeem it early.
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Capped Rate Mortgage
These loans have a fixed ceiling on the interest rate for a period of time, above which your rate will not be allowed to go. If base rate falls, your rate can still fall with it.
Good points: you are protected from interest rises, but free to benefit from falls.
Bad points: application fees may add to the cost of your loan and it can be more expensive than fixed rates or discounts.
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Repayment Mortgage
Your monthly repayments cover both capital and interest on the loan. No other repayment vehicle is needed, but your lender may insist on life insurance in case you die before the mortgage is cleared.
Good points: simple, straightforward and easy to understand. Avoids the risk of investing in the stock market.
Bad points: unlike a pension, ISA or endowment mortgage, repayment loans do not give you the opportunity to benefit from a rising stock market. Also, when moving, people tend to take out a 25 year repayment mortgage each time to keep monthly costs down. Doing this will extend the period for repaying the debt.
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Interest Only Mortgage
With an interest only mortgage, your monthly payments to the lender cover only the interest on the loan (i.e., they don’t repay any of the capital). The full amount of the loan has to be repaid to the lender at the end of the term. To do this, you invest additional funds in investments which are designed to generate enough (preferably more) capital to repay the loan at the end of the term.
Good points: you can choose from a variety of investment vehicles, some of which can have tax advantages. Should you move or remortgage, your investments can generally be reallocated to the new mortgage.
Bad points: unlike a repayment mortgage, the amount of debt does not reduce over time. And there is no guarantee that your chosen investments will grow sufficiently to repay your loan (although you can usually top up your contributions to investments as you go along if this looks likely to be the case).
Click here to look at different interest only repayment options
Endowment Pension ISA
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Endowment Mortgage
Monthly repayments of interest on the loan are payable to the lender and in addition you will make contributions to an insurance company to fund a savings plan which aims to generate sufficient funds to pay off the capital at the end of your agreed mortgage term. The savings plan comes can be “with profits” , “unit-linked” or a combination of them both.
“With profits” policies provide two types of bonuses. A reversionary bonus is usually paid each year and, once awarded, is usually guaranteed provided the policy is still active on the maturity date. A terminal bonus is awarded on the policy maturity date and its size will depend on the performance of the fund over the lifetime of the policy.
With “unit-linked policies”, the value is driven by the underlying value of the investments when the policy reaches maturity (but you can often swap into safer investments a few years earlier if you wish). If you die before the term is complete, the life insurance aspect of the endowment policy is used to clear the loan.
Good points: you can maintain the policy if you move house or change mortgage provider. Endowments can include some kind of life and critical illness cover which is usually cheaper than buying such cover separately. If the underlying investments perform well, you may get more than is needed to pay off the loan. However, if the underlying investments perform poorly you may not have built enough to repay the original capital (see Bad Points)
Bad points: poor investment performance could result in you having to review the premium subscriptions to your endowment policy and/or the basis on which your mortgage is operated in order to ensure that the mortgage loan is repaid in full at the end of the agreed term.
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Pension Mortgage
Monthly repayments of interest on the loan are payable to the lender and in addition you make contributions to a personal pension providing a tax-free lump sum and taxed regular income at retirement. Most, if not all, of the lump sum is used to clear your mortgage loan at that date.
Good points: pension contributions qualify for tax relief of up to 40% (for a higher rate taxpayer), which boosts the value of every £1 you contribute.
Bad points: using your lump sum in this way may leave you with inadequate income in retirement. Also, the lump sum is payable on retirement, so your loan term may be more than 25 years (depending on how old you are and when you are planning to retire!). Poor performance could adversely affect the amount of the tax-free lump sum resulting in insufficient funds available to repay the loan at the end of the agreed term.
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ISA mortgage
Monthly repayments of interest on the loan are payable to the lender and in addition you make contributions to an ISA. Like the Pep mortgages which preceded them, ISA mortgages use stock market-based investments for tax-free growth: there are two main types of ISA: “mini” and “maxi”, which have different rules over contribution levels and range of investments. Term assurance to cover repayment of the loan if you die early will also be required by the lender.
Good points: if your ISA performs well, you may be able to pay off your mortgage early.
Bad points: a stock market crash could leave you in trouble. Also, current tax rules dictate that the maximum investment in an ISA is £7,000 per annum, which won’t be enough to give you confidence that you will be able to repay a large mortgage at the end of the term.
