What kind of mortgage should I get? Good question.

By Iona Bain

It can be startling with all the different types of mortgages out there. Tricky things. Find out which is best for you.

This means you repay the capital and the interest over the set period, usually 25 or 30 years. Before the crash, lenders were allowed to offer interest-only mortgages, where borrowers only had to repay the interest every month, then repay the capital at the end of the mortgage term. These have been virtually outlawed today. 

So, you've got a smooth-running set of outgoings and you've reined in the unnecessary spending. Look at you! Now it’s time to make sure the hard-saved spare cash is put to work in the best way possible, and believe it or not the government is on your side, if you want to know more, here's an article on how to use first-time buyer schemes.

Repayment mortgage

In the early years, your outstanding debt is larger so most of your monthly repayments go towards paying the interest. Gradually, as you reduce what you owe, most of your repayments go towards paying off the debt.

For example, on a £200,000, 25 year mortgage at 2 per cent, you'll pay £848 a month. After 10 years, assuming the rate stayed the same (though it probably won’t) you'll have made £101,760 in payments, but only reduced what you owe by around £68,000. Yet after a further 10 years, if you were to pay in another £101,760, you would only have around £48,000 outstanding. This is because less interest is accruing each year.

If you switch to a new mortgage, you simply take the outstanding debt with you and pick up where you left off. 

Your repayment strategy

When it comes to how long your mortgage should run for, the longer it is the lower your monthly repayments will be. But if you can afford to pay in more, regularly or at any time, and your mortgage allows you to do that without penalty, it can be a great strategy as the debt comes down faster and the overall interest added on shrinks.

So one strategy is to set a shorter repayment period, say 20 years, knowing the repayments will be higher. Or hedge your bets and stick to the classic 25 years, knowing that if interest rates stay pretty low your repayments will stay low enough that you may well, especially if your circumstances improve, pay in more and pay it off earlier. If interest rates rise more sharply than appears likely right now, or if perhaps your circumstances don’t improve, you should have a safety margin for what you can afford. 

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Fixed rates

Fixed rates do exactly what they say on the tin; they allow you to plan your repayments over a fixed period, with you knowing they won’t change.  It might be two, three, five or 10 years. The two-year deals will be the lowest, but it is also possible to bag low rate longer-term deals in the current environment where the big idea is that interest rates are likely to be ‘lower for longer’.

The fact is, rates can’t go much lower, it seems, so fixing appears to make sense as a hedge against rates going back up again. The problem is nobody knows just when they may start to rise or how quickly, so picking your time-frame inevitably means some guesswork.

Variable rates

A variable rate means the lender can put it up (or down) at any time. The lender’s ‘standard variable rate’ (SVR) however is likely to be a relatively expensive option. It’s the rate you are put onto when a fixed term deal comes to an end, and it’s the way lenders make their profits.  Going for a variable rate makes more sense when interest rates are higher and more likely to come down. Some lenders offer ‘discount’ mortgages, slicing a certain amount off the SVR, but that may be disguising the fact that the SVR is high in the first place – they can be anything between 2 and 5 per cent above base rate.

Tracker rates

Tracker rates also pass the “Ronseal” test. They’re like variable rates in that they work better when rates are on a downward trend. A typical tracker would be the Bank of England base rate plus 1.5 per cent – so 1.75 per cent if base rate is at 0.25 per cent, or 2 per cent if the base rate is at 0.5 per cent. They still sound cheap – but if base rate goes to 3 per cent – you are then paying 4.5 per cent.

When rates were soaring, ‘capped’ deals were common, and they could make a comeback in future. Your rate tracks the base rate but is guaranteed not to go above a certain cap. 

Flexibility and fees

A big factor affecting your choice must be flexibility.  Lenders only offer their best deals on condition you see through the fixed term. If you have fixed for three or five years, and decide halfway through there are much better deals around elsewhere, you will have to pay a hefty penalty to switch out.  The one advantage of being on the SVR is you can get off it at any time without penalty.

But just as important as the headline rate on your mortgage is the fees that come with it.

These days most new fixed rate products come in two versions, with or without a fee.  For instance, a recent rock-bottom rate of 0.99 per cent over two years from HSBC came with a £1499 arrangement fee – and was only available on a 65 per cent loan to value.  

But paying £1499 on a loan lasting only two years effectively adds over £62 a month to the cost, on top of your mortgage payment.

It would only make financial sense if you were borrowing at least £220,000.

If you only needed £150,000, there was at the same time a two-year fix available from Norwich and Peterborough Building Society at 1.49 per cent with a much smaller £195 fee – over the course of two years that works out £19.33 per month cheaper.

It’s one for the broker to work out for you.  It may depend on whether you are cash-starved and can’t face an upfront fee, so will settle for slightly higher repayments over the long-term, or whether you are happy to put cash up front now in order to reduce your regular outgoings.  But in many cases, there is a ‘right answer’ in that one version really is a better overall deal than the other one, especially when comparing similar products of different lenders. 

Your mortgage is probably the biggest goal and commitment you are likely to tackle. So it's probably best to hunt down a mortgage broker to advise you which lenders are most likely to accept. If you want to know more about this process click here.

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