Understanding the different types of mortgage. A guide to fixed rate, tracker, discount, variable and capped mortgages

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One of the big decisions you have to make is what type of mortgage deal to take out. Understanding the different types of mortgage and help you get the best deal for you. Read on to find out how they work.

What are the different types of mortgage?
There are over half a dozen different types of mortgage rate to choose from and some that look similar at first glance may be quite different when you scratch beneath the surface.

1. Standard variable rate (SVR): This does what it says on the tin but it’s normally not a good deal. It’s never a rate that lenders promote and it’s not used to win new customers. Mortgage lenders are under no obligation to reduce it when Bank of England base rates fall, but may raise it by more than Bank base rates when they increase.

2. Tracker rate: Tracker rates have become much more popular in recent years since interest rates started plummeting. They track the Bank of England base rate and must fall or rise by an identical amount as soon as base rates change. However, they may have a minimum level (otherwise called a ‘collar’) below which they won’t fall, no matter how low base rates fall.

SAVVY TIP: Be aware that in rare cases lenders have increased tracker rates even when the Bank of England hasn’t changed the base interest rate.

3. Fixed rate: This mortgage rate won’t change for the term of the fix. It’s a good idea if your budget (or personality!) couldn’t cope with a rise in rates, but you will normally pay a premium for that certainty.

SAVVY TIP: You will generally pay an early repayment charge (ERC) if you remortgage during the term of the fix and there are also normally limits on how much extra you can pay off your mortgage (10% a year is not unusual).

4. Discount rate: This rate is linked to the standard variable rate in that you get a discount off whatever the lender’s standard variable rate is at the time. Confusingly, if you’re choosing between two discount rate mortgages that charge the same interest rate, one may be a better deal than the other (because it may have a higher discount off the standard variable rate).

SAVVY TIP: If there’s a tie-in period after the discount rate has ended and you have to go back onto the lender’s standard variable rate, look at the level of the SVR and not just the discount rate you’ll be paying for the first few years.

5. Capped rate: Here your mortgage can’t rise above a certain level but it should fall if the Bank of England cuts interest rates. Some lenders link their capped rates to their tracker rate, others to their standard variable rate and it’s an important difference.

SAVVY TIP: Capped rates linked to a lender’s tracker rate will normally be the cheapest, so it’s worth finding out how the capped rate deal is structured if you’re thinking of signing up to one.

6. Cashback mortgage: Here, you’re given a cash lump sum when you complete on the mortgage deal. These mortgage rates seem to drift in and out of favour, so it’s possible there may not be many on the market when you’re looking for a mortgage. In the past they used to be an expensive way of getting some cash but, from time to time there are one or two cashback mortgages that are on competitive rates.

SAVVY TIP: Always work out exactly what the trade off for getting the cashback lump sum is. You may find you pay a higher interest rate, but that’s not always the case.

7. Stepped interest rate: Here you pay a starting interest rate in the first year and a higher rate in years two and three (sometimes these deals last for longer than three years). These deals have been bad value in the past but, as I write this, there are one or two loans available that aren’t too expensive. However, this is likely to change so you’d have to assess each individual deal.

Action plan:

1. Find out how much it could cost to repay the mortgage every month. Log onto price comparison sites or mortgage brokers’ websites.

2. Compare monthly payment costs of different mortgage amounts by going to mortgage broker John Charcol’s ‘How much can I borrow?’ calculator or to London & Country’s How much will my mortgage cost?calculator.

3. Look at top fixed, tracker, discount etc deals. Try brokers’ sites such as John Charcol, London & Country.

Related articles:

How do standard variable rates compare?

How an offset mortgage can save you money

Getting the best mortgage – the charges and fees that matter

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