Which type of mortgage is right for you?

February 27, 2023

For most of us, buying a home involves securing a mortgage. The last thing you need is the mortgage process adding pressure to what can already be a stressful experience.

That is why our team of expert mortgage advisers at PIL (Protection & Investment Ltd) Southampton feels passionately about using our extensive experience to help you navigate the wide range of options available.

You may only go through the mortgage application a handful of times in your lifetime.

We, on the other hand, are working on mortgage applications every day. Scouring the marketplace to keep up to date on all the providers’ mortgage products and their associated terms and conditions.

All of which makes us well placed to help you to find the best deal to suit your circumstances.

In this article, we talk through the main types of mortgage available: Interest Only, Repayment, Variable Rate and Fixed Term. We cover their key differences and the potential pros and cons.

Everyone’s circumstances are unique. It is our job, at PIL Southampton, to get to know you and to ask the right questions so that we can help you to work out the best option for you. Not just for now, but for the future.

Interest-only mortgage

Unlike a repayment mortgage, with an interest-only mortgage your monthly mortgage payments only cover the interest on the loan, not the loan itself (the principal amount).

This arrangement could be for the whole duration of the mortgage but it is more likely to be for the first 7-10 years of the mortgage term, after which you will start to pay off the principal loan as well as continue to pay the interest on that loan.

Only paying the interest makes the monthly mortgage payment attractively lower BUT you generally pay a higher interest rate on an interest-only mortgage, which means that overall, in the long term, you will be paying more money back to the lender.

Also, as you are only paying the interest on the mortgage and not the principal amount, you have to make sure that you have robust plans in place for when your mortgage term is up and it is time to repay, in full, the principal amount of the loan.

When this time comes, some people choose to sell the home they have mortgaged, to release capital and pay off the outstanding mortgage. This is quite common in buy-to-let scenarios. Others choose to re-finance their loan after the interest-only term period has expired.

Another option is to pay off the principal loan with a lump sum, if you have been able to save and/or invest money in other ways during your interest-only mortgage term.

Typically, lenders require you to provide a higher deposit for an interest-only mortgage, and for you to have a higher income than if they were lending for a repayment mortgage.

Advantages of an interest-only mortgage

The payments are generally lower and therefore more affordable than with a repayment mortgage. This can free up cash flow for other expenditure and can be particularly attractive to first time buyers who may be at an earlier stage in the careers. They could be hoping to have higher incomes in the future, and therefore more disposable income, which would enable them to more comfortably increase their mortgage payments.

It is a good option for a buy-to-let property as it keeps the landlord’s overheads lower and selling the property when the principal loan amount needs to be repaid would not affect the property owner’s own living arrangements.

You have the flexibility of choosing how to invest any surplus funds that are not required for your mortgage payments during the interest-only term.

Interest-only mortgage disadvantages

Interest-only mortgage deals can be harder to find and secure, particularly for first-time buyers. Also, they generally require a bigger deposit and a higher income, which can cancel out the benefits of having lower monthly repayments.

The higher interest rates of an interest-only mortgage mean that you will be paying more for your mortgage over the whole term.

Whilst you are only paying the interest part of your mortgage, you are not building up any equity in your property – only the repayment of the principal debt can do that. Also, you will be paying interest on the principal amount throughout the term of the mortgage rather than on a decreasing capital amount.

You may not have the extra finances available to pay for the higher mortgage payments when the interest-only period ends.

Banks generally view interest-only mortgages as a higher risk loan than a repayment mortgage, due to the borrower having to come up with a large lump sum at the end of the term.

There is a risk of a shortfall – if your repayment method doesn’t perform as well as you hope over the mortgage term you may not have enough funds to pay off the principal amount when the time comes.

Repayment mortgage

A repayment mortgage is the most common type of mortgage. It means that you repay part of the mortgage loan and the interest on that loan at the same time, in your monthly mortgage payments.

This is fundamentally different to the interest-only type of mortgage, where you are only paying the interest on the loan, not the principal part of the loan itself.

With a repayment mortgage, because you are paying off the capital part of the loan every month, your monthly repayments decrease over the length of your mortgage term. This is because, as the principal amount reduces, the interest will continually be recalculated to the lower capital amount.

Advantages of a repayment mortgage

You have the guaranteed confidence that your mortgage will be fully paid up at the end of your mortgage term.

Your equity increases at a faster rate because the more you pay off, the less you owe; the less you owe, the more of the property you own.

As the interest rates offered on a repayment mortgage are lower than interest-only mortgages, you will be paying less interest over the whole term which makes the mortgage a cheaper loan in the long run. In addition, you will be paying interest on a decreasing capital sum which will reduce the amount you pay in interest over the term of the loan.

Disadvantages of a repayment mortgage

Monthly repayments are higher than with an interest-only mortgage, because you are paying back the principal loan amount as well as the interest on it.

In the first few years of a repayment mortgage’s term, a bigger proportion of your monthly payment is paying the interest rather than the capital. Over time, this balance shifts, with more of your monthly payment going towards paying off your loan and less going towards the interest.

Variable rate mortgage

With a variable rate mortgage, the interest rate and therefore your monthly repayment can change at any time.

It can be a tracker mortgage, which tracks the Bank of England’s base rate, for example if the Bank of England’s base rate increases or decreases by 1%, so too will your monthly repayment.

A standard variable rate mortgage works in the same way, except the interest rate is tracking the lender’s own interest rate. Usually, lenders change their rate in line with the Bank of England, but they don’t have to. So, in theory, your standard variable rate mortgage rate could change at any time.

Variable rate mortgage advantages

These types of mortgage have more flexibility as you are not tied into a particular rate – if interest rates fall during your mortgage term, you benefit through lower interest rates and lower repayments.

Standard variable rate mortgages generally don’t have early repayment charges, which can be helpful if you want to move your mortgage without paying a penalty. They also often have flexibility regarding making over payments.

Variable rate mortgage disadvantages

The fact that your mortgage payments are not fixed and can fluctuate, can make it difficult to budget your finances if the interest rate goes up.
If you have a tracker variable rate mortgage, there may be an early repayment charge which means you will have to pay a financial penalty if you want to end your mortgage deal before the end of the deal term.

Fixed-rate mortgage

A fixed-rate mortgage means that the interest rate will be the same throughout its term, so your monthly repayments will be guaranteed not to change. The term of a fixed-rate mortgage is usually two years, three years or five years.

Fixed-rate mortgage advantages

Knowing exactly what your repayments will be each month makes it easier for you to manage your money.

When base rates are relatively low, you can capitalise on this by locking in a favourable fixed rate, knowing that, if base rates later rise, you will be protected from your repayments rising.

Fixed-rate mortgage disadvantages

Interest rates on fixed-rate mortgages tend to be higher than variable rate mortgages, as you are paying a premium for certainty.

If base rates and interest rates fall, your repayments will stay the same, so you will miss out on the benefits of lower interest rates leading to lower monthly mortgage repayments.

Fixed-rate mortgages usually come with fairly high arrangement fees and early repayment charges if you choose to end your mortgage before your fixed term ends. They also tend to have restrictions on over payments.

How PIL Southampton can help you

Our priority is to use our extensive experience and knowledge to ease this potentially complex process for our customers, and we pride ourselves on securing the best deals we can for our hundreds of satisfied clients. We would love to help you in the same way!

How you can contact PIL Southampton

Our friendly, knowledgeable mortgage advisers are here to guide you through the mortgage process, minimising the stress from start to end. You can email us, fill out the contact form on our website or call us on 02380 668407.