Mortgage interest types explained

There are various different mortgage rates & deals available to potential borrowers such as; fixed, discounted, capped, tracker and it can get confusing when trying to weigh up which is the best deal for you – for your convenience we have listed explanations & illustrations below to explain the most popular types available.

The mortgage type &  deal that’smortgage types best for you & your family will depend on your individual needs & circumstances, we would always recommend speaking to a mortgage professional to obtain the best advice possible.

The two main types of mortgages most people know about are interest only and capital repayment. These are fairly straightforward to understand – with a capital repayment mortgage, each monthly mortgage payment goes towards repaying the capital owed and the interest, so the mortgage should be fully repaid at the end of the term. An interest only mortgage means that your monthly payments simply pays the interest on the loan and the capital (what you borrowed) will be paid in a lump sum at the end of the mortgage term.

Other popular but not so obvious interest rate types have been listed below:

Standard variable rate mortgage

standard variable rate mortgageA lender’s standard variable rate mortgage is what a lender uses as their ‘standard’ rate of interest.

The rate and subsequent mortgage payment will rise and fall in line with the lenders standard rate of interest.

The lenders standard variable rate will tend to follow the Bank of England base rate fluctuations. So, if the Bank of England base rate rises or falls, the lenders standard variable rate will normally follow suit shortly after at the lender’s discretion.

One of the benefits of a standard variable rate is that if interest rates are low, then the associated mortgage payments should be low.

Discounted interest rate

discounted mortgage rateDiscounted rate mortgages allow a discount on the lender’s standard variable rate over a set period of time and are offered as an incentive for borrowers to go with certain lenders.

A discounted rate can be beneficial if you feel interest rates are going to be low over the first few years of your mortgage. A discounted rate will always be lower than the lender’s standard variable rate.

For example, if you get a discount of 1.5% for 2 years – you will benefit from a rate of 1.5% less than the lenders standard variable for a period of 2 years.

If interest rates go up, your payments will also increase. However, they will still remain lower than the monthly payments associated with the lenders standard variable rate. It’s important to consider all factors such as future interest rate movements.

Tracker interest rate

tracker rate mortgageTracker rate mortgages allow borrowers to get an interest rate that tracks the Bank of England base rate. As with any variable interest rate, rates can go up as well as down and your tracker mortgage will follow suit.

Whilst you can benefit whilst rates are low, you could get penalised if rates rise over and above what you are expecting.

With any variable rate, that is a rate that is not fixed or capped in some way, there is always the danger that rates can increase substantially.

Fixed rate mortgage

fixed rate mortgageFixed rate mortgages are fairly simple to understand and as the name suggests the interest rate is ‘fixed’ for a set period of time and will not alter. Even if variable rates increase drastically a fixed rate mortgage & associated payments will not alter.

It stands to reason that if rates fall below your fixed rate, you will not benefit from lower payments. However, if you get one of the best fixed rates available, most borrowers will be happy with this, knowing that the mortgage payment will not change for a number of years.

Fixed rate mortgages are becoming ever more popular to help homeowners budget, safe in the knowledge that they know exactly how much is going to be paid out each month.

Capped rate mortgage

capped mortgage rateCapped rate mortgages are similar to fixed rate with a touch of tracker thrown in!

A capped rate mortgage will allow the interest rate to fluctuate. If rates go down you will benefit from a lower monthly payment, however they have an upper limit (a ‘cap’) that the interest rate will not exceed for a set period of time.

For instance, a 2 year 5% capped mortgage will allow you to benefit from the lender’s variable rate, if it’s below 5%. But, if the lender’s variable rate exceeds 5% your ‘cap’ will prevent your mortgage rate from exceeding this.

You will know the maximum your monthly payments could be during the capped rate period. As with a fixed rate mortgage it should help with budgeting, give peace of mind and you could benefit from lower payments if interest rates fall below the ‘cap’.

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