Deciding which type of mortgage to go for is a big financial decision. Get it right and you could save yourself thousands of pounds, get it wrong and it could cost the same!
It's likely that your mortgage is by far your biggest financial commitment, so choosing the right deal for your needs is essential.
We run through the pros and cons of three popular types of mortgage; fixed, tracker and discount, to help you choose the best one for your circumstances.
Fixed rate mortgages
What are they?
A fixed rate mortgage deal is one which offers fixed repayments for a set period, usually between 2-5 years
This is because it guarantees the rate of interest applied to your mortgage for the term regardless of any changes to the Bank of England base rate or the lender’s standard variable rate.
Pros
When you sign up to a fixed rate mortgage the interest rate applied to your borrowing, and therefore your monthly repayments will be set for the duration of the deal.
This means you’ll know exactly what you have to pay each month and be able to budget accordingly.
It also means that if interest rates rise during your fixed rate term you won’t see your payments increase accordingly, and you could end up paying less than someone on a tracker or variable rate mortgage.
Cons
Fixed rate mortgages usually apply a rate of interest that’s slightly higher than that charged by other types of mortgage.
This is because you are paying for the stability they offer and the reassurance that your interest rate won’t rise during the agreed term.
If rates do increase you’ll be protected.
However, this also means that if rates stay low or drop during the term of your fixed rate mortgage deal you will be paying over the odds compared to someone on a tracker or discount mortgage.
Who do they suit?
If you want your monthly repayments to be the same every month for the foreseeable future then a fixed rate mortgage deal is likely to be your best choice.
Typically if you are a first time buyer or don’t have lots of spare income then a fixed mortgage can give you the reassurance on knowing what you’ll pay each month.
Once you decide to fix you’ll need to decide how long you want to fix for. Read this article to find out about your options.
Tracker mortgages
What are they?
A tracker mortgage is usually linked directly to the movement of the Bank of England base rate.
The rate of interest applied to your borrowing will be set a fixed amount above the base rate and it will increase and decrease throughout your mortgage term in line with the movements of the base rate; your repayments will increase and decrease accordingly.
Pros
A tracker mortgage usually starts off as a cheaper option than a fixed rate mortgage, this is because they advertise lower interest rates as there is no guarantee you will pay the initial rate for the full term.
As a result you would be paying less in interest each month providing interest rates stay low. If interest rates fell further, the drop would be reflected in your monthly repayments which would also fall.
Cons
When you take out a tracker mortgage you're accepting the fact that your repayments can change each month.
While the amount you need to repay will fall if the base rate falls, any rate rises will be passed directly on and you will see your repayments increase.
This makes budgeting trickier as it's plausible your repayments could rise significantly over the term - this can be a particular problem if you don’t have a lot left over at the end of each month.
Who do they suit?
If you can afford to accept the risk that your repayments could rise over your mortgage term in return for a lower rate initially, then a tracker mortgage could be the one for you.
However, you will need to be sure that you could still afford to pay your mortgage should rates increase in the future.
Discount mortgages
What are they?
Discount mortgages are very similar to a tracker mortgages in that the rate of interest applied isn’t set, it can vary from one month to the next.
The main difference is that a discount mortgage is linked to your mortgage provider's Standard Variable Rate (SVR), not directly to the Bank of England Base rate.
Pros
Often discount mortgages offer the cheapest initial interest rates. This means that you could start off paying less for you mortgage than if you choose a tracker or a fixed rate mortgage.
Cons
Like a tracker mortgage, there's no guarantee as to how much you will need to repay each month. This is particularly the case as your bank can alter their SVR whenever and by however much they like.
Take out a discounted mortgage and you’re accepting the risk that the rate of interest applied to your borrowing – and therefore your repayments - may increase significantly throughout the term.
You can’t assume that you’ll feel the benefit if the rates available on the market fall either as your bank is under no obligation to reduce your interest rate accordingly. However, should interest rates start to climb, you can rest assured that these will be passed on and you'll face paying more each month.
Who do they suit?
Like a tracker mortgage, if you want to pay as little interest as possible at the start of your deal and can afford to pay more if needs be, then a discounted mortgage may be a good choice.
However, discounted mortgage deals are perhaps even more of a gamble than trackers as the decision to increase interest rates is your lender's alone. This opens up the possibility that the your repayments will increase by a significant amount over the mortgage term.
Best of both worlds
If you want the security of a fixed rate mortgage but don’t want to miss out on the best deals then there are number of ways that you could get the best of both worlds.
Jump ship
Some mortgage providers will allow you to take a tracker or discount mortgage and then switch to a fixed rate mortgage if rates start to creep up within a certain time period.
Ordinarily you could be clobbered by high early repayment charges if you switched providers but if you stick with the same mortgage company you could be exempt from these fees. You would also avoid having to pay legal and valuation fees as you would be switching mortgage product rather than changing your provider.
This option isn’t available from all providers and on all tracker and discount mortgages. It's also usually only available for a limited time – often the first 6 months of your deal - but it's still an option worth investigating if you're unsure whether to track or fix.
Split your mortgage
You can now combine the benefits of a fixed rate mortgage with those of a tracker mortgage by splitting your mortgage in two.
A split mortgage allows you to hedge your bets by fixing a portion of your mortgage at a fixed rate while keeping the rest on a tracker mortgage which would follow the Bank of England base rate.
Pre-book a fixed
If you are worried that mortgage rates could shoot up in the coming months then you can get the best of both worlds by pre booking a fixed rate mortgage deal while rates are still low.
Read our guide Should You Pre-Book a Mortgage Deal Now? for more information.
Get advice
While these are the main types of mortgage there are numerous other options available.
You should compare the total cost all of your options before you commit to a new mortgage deal and always get advice from an independent, whole of market mortgage broker if you're at all unsure.
