Understanding Mortgage Rates: How do Mortgages work?

Welcome to Three Keys Mortgages, your trusted partner in navigating the complex world of mortgage options. Whether you're a first-time buyer, looking to invest in property, or looking to remortgage, understanding the various types of mortgages available is crucial. This guide will help you explore the different types of mortgages in the UK, ensuring you make informed decisions tailored to your financial situation and goals.

Fixed Rate Mortgage

A fixed-rate mortgage offers a consistent interest rate for a set period, typically between 2 to 5 years, though longer terms are available up to 30 years. This type of mortgage is ideal if you prefer predictable monthly payments, as the interest rate remains unchanged throughout the fixed period. For example, if you secure a 5-year fixed mortgage at 3%, your interest rate and monthly payments will stay at 3% for the entire 5 years, regardless of changes in the market. This predictability allows for better budgeting and peace of mind, as you are shielded from any potential interest rate hikes during this period.

Once the fixed term ends, your mortgage will typically revert to the lender’s Standard Variable Rate (SVR), which can fluctuate. It's wise to plan ahead and start looking for new deals as your fixed period nears its end to avoid higher payments. You can initial a product switch (which means changing the mortgage deal but staying with the same lender) or a remortgage (which means moving to a new lender) up to 6 months before the end of your deal. If you did the previous mortgage with Three Keys Mortgages, we will be in touch with you to remind you your deal is coming to an end, and put a plan in place to ensure you get the best out of your mortgage going forward.

Standard Variable Rate (SVR) Mortgage

An SVR mortgage has an interest rate that the lender can change at any time. This rate usually applies once the initial fixed or tracker period ends. The primary benefit of an SVR mortgage is its flexibility. There are no early repayment charges, allowing you to make overpayments without penalties. For instance, if you receive a bonus at work, you can make extra payments to reduce your overall mortgage balance. If the lender lowers the SVR, your monthly payments will decrease accordingly, potentially saving you money.

The major drawback is the unpredictability. Payments can increase unexpectedly if the lender raises the SVR, making it difficult to budget long-term. SVR mortgages are often not the most cost-effective option due to these potential rate fluctuations and generally higher rates compared to introductory deals.

Tracker Mortgage

A tracker mortgage is a variable-rate mortgage that follows a specific base rate, usually the Bank of England’s base rate. The interest rate is set at a margin above this base rate, meaning that changes in the base rate directly affect your mortgage payments. For example, if the Bank of England’s base rate drops from 1% to 0.5%, and your tracker margin is 1%, your mortgage rate would drop from 2% to 1.5%. This transparency in rate adjustments can be beneficial, especially in times of falling interest rates, as your payments will decrease.

On the downside, if the base rate rises, your payments will increase correspondingly. This variability can make it challenging to plan your finances, and in periods of rising interest rates, your mortgage could become significantly more expensive.

One key benefit of tracker rate products is that some of them do not have early repayment charges, which means you can over pay any amount, whenever you like, but also you can switch into a fixed deal at any time. This can provide flexibility if you are not sure of your near future plans or if rates are currently set to fall.

Discounted Mortgage

A discounted mortgage offers a reduction on the lender’s SVR for a set period, usually 2 - 5 years. The discount remains constant, but since it's based on the SVR, your payments can still fluctuate. For example, if the SVR is 5% and you get a 2% discount, your initial rate would be 3%. This can make discounted mortgages more affordable initially compared to fixed rate deals.

The uncertainty remains as payments can increase if the SVR rises. Different lenders offer varying discounts, so it's essential to compare offers to find the best deal. While discounted mortgages can provide initial cost savings, the potential for rising payments should be carefully considered. Keep in mind that unlike SVR mortgages, the discounted deals often do have an early repayment charge if you do wish to break out of the deal before the end.

Offset Mortgage

An offset mortgage links your mortgage to a savings account, using the balance in your savings to reduce the amount of interest you pay on your mortgage. For instance, if you have a £200,000 mortgage and £20,000 in savings, you only pay interest on £180,000. This can lead to significant interest savings over the term of the mortgage, making it an attractive option for those with substantial savings.

The savings used to offset the mortgage are not subject to tax, providing a tax-efficient way to manage your mortgage. However, these savings do not earn interest, as they are offsetting the mortgage. Offset mortgages might have slightly higher interest rates compared to traditional mortgages, so it's essential to weigh the benefits of potential interest savings against the higher rates.

95% Mortgage

A 95% mortgage allows you to borrow up to 95% of the property's value, requiring just a 5% deposit. This is particularly beneficial for first-time buyers who may struggle to save for a larger deposit. For example, for a £200,000 property, you only need a £10,000 deposit. This lower deposit requirement makes homeownership more accessible for many people.

Due to the increased risk to the lender, 95% of mortgages generally come with higher interest rates. There's also a higher risk of falling into negative equity if property values decline, meaning you could owe more than the property is worth. It’s crucial to consider these risks and ensure that you have a stable financial situation before opting for a 95% mortgage.

Help to Buy (not currently available. New schemes do exist, get in touch to find out)

Help to Buy is a government scheme that assists buyers with a 5% deposit, supplemented by a government equity loan. The loan can be up to 40% of the property value in London or 20% outside London. This scheme is designed to help first-time buyers and those looking to move up the property ladder by reducing the amount they need to borrow from the mortgage provider.

For example, if you want to buy a £300,000 home, you would provide a £15,000 deposit, the government could provide a £60,000 equity loan (outside London), and you would take out a mortgage for the remaining £225,000. This setup can lead to more favourable mortgage rates due to the lower loan-to-value ratio. The equity loan needs to be repaid, and there are restrictions such as not being able to rent out the property.

Shared Ownership

Shared ownership allows you to purchase a share of a property, typically between 25% and 75%, and pay rent on the remaining share owned by a housing association. This scheme provides an affordable entry into homeownership, particularly for those who cannot afford to buy a property outright. For instance, buying a 25% share of a £200,000 property would require financing £50,000, making the initial cost much lower.

Over time, you have the option to buy additional shares in the property through a process called staircasing, eventually allowing you to own the property outright. You will still need to pay rent on the remaining share until you purchase the full property. Shared ownership can be complex, and it’s advisable to seek advice from a broker like Three Keys Mortgages as well as legal advice and consider setting up a deed of trust to outline ownership shares.

Flexible Mortgage

A flexible mortgage offers the ability to adjust your payments to suit your financial situation. This includes making overpayments, underpayments, and even taking payment holidays. For example, if you receive a large bonus, you can make an overpayment to reduce your mortgage balance and save on interest. Conversely, if you experience a temporary reduction in income, you can make underpayments or take a payment holiday, providing financial relief.

This flexibility can be incredibly beneficial, allowing you to manage your mortgage in line with your financial circumstances. Terms and conditions vary significantly between lenders, and some flexibility options may come with fees. It’s important to thoroughly understand the specific terms of a flexible mortgage before committing.

Buy to Let Mortgage

A Buy to Let mortgage is designed for purchasing property to rent out. These mortgages are typically interest-only, meaning you only pay the interest each month and repay the capital at the end of the mortgage term. This setup can make monthly payments lower, allowing rental income to cover the mortgage payments. For example, renting out a property for £1,000 a month can cover your mortgage payment if the interest-only payment is lower.

Buy to Let mortgages require a larger deposit, usually around 25% of the property value, and rental income is a critical factor in determining how much you can borrow. There are additional costs, such as a 3% Stamp Duty surcharge in England and Northern Ireland, and the risk of void periods where the property is not rented out, but costs such as mortgage repayments and maintenance still need to be covered.

Joint Borrower Sole Proprietor Mortgage

A Joint Borrower Sole Proprietor (JBSP) mortgage is a unique type of mortgage in the UK designed to help individuals, particularly first-time buyers, afford a property by allowing additional borrowers, typically family members, to contribute to the mortgage repayments without being co-owners of the property. This arrangement is beneficial as it increases the applicant’s borrowing capacity, making it easier to qualify for a larger loan. The primary advantages of a JBSP mortgage include enhanced affordability for buyers and potential stamp duty savings, as only the sole proprietor is considered the property owner and is the only person on the title deeds. However, there are also drawbacks to consider: the additional borrowers share the responsibility for the mortgage repayments, which could impact their own borrowing capacity and financial plans. Moreover, since the property is solely owned by the primary borrower, the contributing family members have no legal claim to the property, which could lead to complications if personal circumstances change.

Guarantor Mortgage

A guarantor mortgage involves a third party, usually a parent or relative, who agrees to cover mortgage repayments if the borrower cannot. The guarantor’s property or savings are used as security, providing reassurance to the lender. This setup allows individuals with no deposit or poor credit to secure a mortgage. For example, a young buyer with no savings might secure a mortgage with the help of a guarantor.

The guarantor takes on significant risk, as their property or savings are at stake if repayments are missed. Guarantors need to understand their responsibilities and potential liabilities fully. Requirements for guarantors include being a homeowner with a good credit score and sufficient income or equity to cover the mortgage if needed.

Choosing the right mortgage is a critical decision that requires careful consideration of your financial situation and long-term goals. At Three Keys Mortgages, we are dedicated to helping you find the mortgage that best fits your needs. Whether you’re a first-time buyer, an investor, or looking for flexibility, our team guides you every step of the way.

For more insights and information, be sure to check out our other articles on the website. If you're in the market for a mortgage, don't hesitate to contact our mortgage specialists at www.3keysmortgages.co.uk. We're here to help you navigate your options.