The type of mortgage you choose can have a big impact on your finances
We’re looking at the key mortgage types, when they might be suitable and any risks you should know about. Here’s what you need to know
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Fixed rate mortgage
The first fixed rate mortgages were launched in the late 1980s and have since become the most popular type of mortgage on the market because they’re often cheaper than opting for a variable rate.
A fixed rate mortgage is just that. You’re offered a set interest rate for a specified amount of time, usually between two and 10 years and during this time your monthly payments stay the same. This is the case even if wider interest rates change.
The fixed rates you’re offered will depend on the length of the term and your loan to value (LTV) percentage – the lower the LTV, the better the rate.
What is loan to value (LTV)?
LTV is the amount you owe on your mortgage shown as a percentage of the property value.
To calculate your LTV, divide the amount you owe on your mortgage by the property’s current value and multiply by 100.
Example: £200,000 (loan) / £300,000 (value) x 100 = 67% LTV
Having a lower LTV, or a bigger deposit, means you can often access better mortgage rates and have more money in your home.
Why get a fixed rate mortgage?
Fixed rate deals are usually cheaper than your basic Standard Variable Rate mortgage (SVR).
Right now, the average two year fixed mortgage rate is 4.84% (based on a 40% LTV) , according to property website Rightmove. If you borrowed £200,000, your monthly repayments would be around £1,150. Compared to an average SVR mortgage, which charges 8.54%, you’d save £465 per month.
If you opted for a five year fix, the average rate is currently 4.42%, based on the same values above. You’d pay roughly £1,102 per month on a £200,000 mortgage, a saving of £513 compared to the SVR.
If predictability in your budget is important to you, then a fixed rate deal is worth considering. Mortgage payments are usually the largest expense most people have, so having fixed payments for a set amount of time can be reassuring.
It may also make sense to fix when the wider Bank of England rate is steadily increasing and you want to lock in a lower rate. Just bear in mind though that it works both ways. Committing to a fixed rate mortgage means you’ll still be paying the same amount, even if wider rates drop.
What to watch out for
Most fixed rate deals come with strict conditions which include restrictions on making overpayments.
On my mortgage, I have a monthly overpayment limit set by the lender. It means that during a 12-month period I can make one or more overpayments totalling up to 10% of the original mortgage balance without paying a charge. It’ll differ between lenders, so be sure to check.
There’s also a risk that you’ll miss out on lower interest rates during the term, if they fall. You can technically leave any fixed rate deal early if you decide it’s better to switch, but you’ll most likely need to pay an early redemption charge (ERC).
The ERC you’ll pay is usually a percentage of the entire mortgage you still owe and is typically between 1% and 5%.
Using an example of a £200,000 mortgage, here’s what you could pay if you leave the mortgage before the term ends:
| ERC | ERC amount | |
| Leaving the deal in year one | 5% of £200,000 | £10,000 |
| Leaving the deal in year two | 4% of £200,000 | £8,000 |
| Leaving the deal in year three | 3% of £200,000 | £6,000 |
| Leaving the deal in year four | 2% of £200,000 | £4,000 |
| Leaving the deal in year five | 1% of £200,000 | £2,000 |
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Tracker mortgage
A tracker mortgage charges interest at a fixed percentage on top of a base rate. In most cases this is the Bank of England base rate, but could be the Libor rate (London InterBank Offered Rate) for specialist mortgages like buy-to-let.
With a tracker, the interest rate you’re charged follows the movement of the base rate so your monthly payments can change.
Here’s how it works:
Let’s say you have a £200,000 mortgage and the base rate is set at 5.25%. If you opt for a two year deal that tracks at 0.15% above the base rate, your equivalent interest rate would be 5.40% (5.25% + 0.15%). This would cost you £1,216 per month.
If the base rate then dropped to 5%, your rate would drop to 5.15%, reducing your payment to £1,187. But if the base rate went up to 5.5%, your tracker would be 5.65%, increasing your payment to £1,246.
Tracker mortgages tend to be more popular when the base rate is steadily decreasing because payments follow suit and reduce.
Most tracker deals are offered for two or five years. You may be able to find a lender still offering a lifetime tracker which tracks the base rate for the entire term of the mortgage, although these are rare.
The Bank of England meets eight times a year to decide on base rate changes. If your payment is going to change, you’ll usually be told within 14 days.
Why get a tracker mortgage?
If the base rate goes down, you’ll benefit from lower monthly payments. Using the example above, you’d pay £29 less each month if the base rate was reduced by 0.25%.
Many trackers don’t charge an early repayment charge (ERC) for leaving the deal early. That said, always check the conditions before signing up so you know you can definitely switch without paying an ERC.
What to watch out for
If the base rate increases, so will your monthly payment. And the difference can be huge. The base rate climbed from 4% to 5.25% between February and August 2023.
If at that time you had a deal that tracked at 0.15% above the base rate and a balance of £200,000, your monthly payments would have jumped from £1,072 to an eye-watering £1,216.
Tracker deals tend to be more expensive than fixed rates. On Natwest’s two year fix at 4.69%, you’d pay £1,133 per month. Their two year tracker with an initial rate of 5.94% would increase payments to £1,281.
Also bear in mind that some trackers don’t charge an arrangement fee while others charge well over £1,000. If you’ve paid a fee for the tracker, only to leave early and then have to pay another arrangement fee for a new deal, the costs can soon mount up.
Some lenders set an interest rate ‘floor’ which is a limit on how low your rate can drop to. If rates drop below this limit, your payments won’t change until the base rate increases back up above the tracker floor.
So if your deal had a floor rate of 2% and the Bank of England interest rate went down to 1%, you’d still pay 2% interest on your mortgage. Without this floor rate, on a £200,000 mortgage, you’d save £94 a month.
Standard Variable Rate mortgage
One of the original mortgage types, this is an oldie, but not so much a goodie.
An SVR is the most basic type of mortgage. You’re not tied into it so you can remortgage any time without paying an ERC but the interest rate you’re charged can go up or down at any time. Lenders tend to change their SVR to move with Bank of England rate changes.
The average SVR is 8.54% (as of July 2024) which is a lot higher than most fixed rate deals. And as we’ve mentioned above, it could cost you hundreds of pounds more each month compared to a fixed rate mortgage.
Why get an SVR mortgage?
If you’re not likely to own your home for long, perhaps you’re planning on selling up to move in with a partner or you’re moving countries, then you could consider an SVR for a short-term mortgage.
If you keep a close eye on the economy and think interest rates are going to keep going down over the coming months, then you might want to consider an SVR but that’s hard to predict.
The good thing about an SVR is that with most lenders, you can switch to a fixed rate deal at any time and you won’t have to pay an ERC. So, if rates do start to increase, you can switch fee-free before your monthly payments skyrocket.
What to watch out for
SVR’s are usually the most expensive mortgage option and one of the biggest risks is the unpredictability of the interest you’ll pay. Without that certainty it can be harder to budget for the long-term. If you do opt for a variable rate mortgage, keep a close eye on the wider Bank of England rates so you can be ready to take swift action and take a fixed deal if you need to.
Offset mortgage
An offset mortgage links your loan to your savings or current account balance to reduce the amount of interest you pay on your mortgage.
Each month, the lender deducts your savings or current account balance from your total mortgage and then charges interest on the lower remaining amount. For example, if your mortgage was £200,000 and you had £20,000 in savings, you’d only be charged interest on £180,000.
The savings balance doesn’t actually repay the mortgage loan. Instead it sits alongside it and is used to calculate interest. The more you keep in savings month to month, the less interest you’ll pay on your mortgage.
Why get an offset mortgage?
An offset mortgage is worth considering if you have a savings balance you’re intending to keep locked away for a longer period of time.
If you can afford to keep your repayments at the same amount each month even with the reduced interest charges, you’ll also benefit by paying your mortgage off sooner.
Say you had a £200,000 mortgage. If you kept £20,000 in savings over the 25 year term and kept your monthly mortgage payments the same, based on an interest rate of 6.39%, you could repay your mortgage nearly four years earlier and save over £31,000 in interest.
What to watch out for
The interest rate tends to be higher for offset mortgages, so use the lender’s online calculator to check your savings balance will be high enough to make it worth it.
Barclays currently have a five year offset mortgage available at 6.5% but one of their best five year fixed rates is 4.65%. On a £200,000 loan this is a difference of around £222 per month. So in this example, the amount of interest you’d save each month would have to be greater than £222 to make it a better option than the fixed rate.
If you decide to withdraw your savings, you’ll pay more mortgage interest as a result. And bear in mind that taking an offset mortgage means you won’t be earning any interest on your savings as it’s all used to save interest on your loan.