Different types of mortgages

How mortgages work

When you take out a mortgage you agree an overall term, such as 25 years.

If you take out a fixed rate mortgage, it will usually be over a shorter period, for example, 2, 3 or 5 years. Many borrowers switch to a new deal at the end of the fixed rate period. This helps them avoid higher standard rates set by the lender.

How interest on mortgages is charged

The mortgage deals you can choose from come in many different shapes and sizes and can last for one year, up to 15 years or even longer.

The lender charges you interest on what you borrow, and your rate of interest can be fixed or variable dependent on the mortgage product you choose.

Let’s run through the most common types:

Fixed rate mortgages

A fixed rate mortgage is where your interest rate is set for an agreed period. A two-year fixed rate at 3% for example, simply means you pay an annual interest rate of 3% for 2 years.

Whilst within the fixed rate period, your mortgage rate will not change, no matter what happens to the wider economy and interest rates.

At the end of the fixed rate you can switch to a new mortgage deal, or you will automatically move onto your lender's Standard Variable Rate.

Pros and cons

The pros of fixed rate mortgages are:

• your monthly payments stay the same during the fixed period
• your interest rate will not increase, even if wider rates rise
• budgeting is easier and more predictable

The cons of fixed rate mortgages are:

• You will not benefit if interest rates fall
• early repayment and exit charges may apply
• your payments may increase when the fixed period ends if rates are higher

Who do fixed rate mortgages suit?

Nearly all borrowers suit fixed rate mortgages. They're easy to understand and offer peace of mind that your monthly repayments are set in stone.

They're particularly useful for first-time buyers who are dealing with other costs of buying, decorating and furnishing a home. Fixed rates allow you to budget and plan your finances.

Variable rate mortgages

A variable rate mortgage goes up and down in line with wider interest rates. This means your mortgage rate could change.

You take out a variable rate over an agreed period, such as two years or five years for example. At the end of your deal period you may move automatically onto the lender's Standard Variable Rate (SVR) unless you remortgage.

There are different types of variable rate mortgages. These are:

Standard variable rate (SVR) mortgages

The lender’s default rate. You'll move on to this at the end of a special deal, and it is usually more expensive than other types of mortgages.

Discounted rate mortgages

A discounted rate for an agreed period when compared to the lender’s SVR (such as a 2% discount for two years). Your pay rate will go up and down in line with the lender’s SVR and according to your set discount.

Capped rate mortgages

This is like a discounted rate, but there’s a maximum rate above which your rate cannot go, known as the cap.

Tracker mortgages

The rate on tracker mortgages can move up and down. This is linked to the Bank of England base rate, plus a set margin (such as 2% above the base rate).

When the base rate goes up or down, your tracker rate automatically follows it at the agreed margin. These mortgages are very transparent as the lender does not control your mortgage rate.

Pros and cons of variable rate mortgages

The pros of variable rate mortgages are:

• your payments may fall if interest rates go down
• many variable deals allow more flexible overpayments
• some variable rates have no early repayment charges

The cons of variable rate mortgages are:

• your payments may increase if interest rates rise
• payment changes can make budgeting harder
• some deals still charge penalties for switching early

Who do variable rate mortgages suit?

Variable rates are suitable if you’re prepared to accept a level of risk with your mortgage. If rates rise, your mortgage payments could rise, and there may be no upper limit.

Variable mortgages provide flexibility. They typically do not have Early Repayment Charges, so you can pay off the mortgage early or make extra payments without penalties.

However, if you need certainty of payment a fixed rate mortgage may be a better option.

Switching mortgages

When your mortgage deal ends you have two choices:

Do nothing

You’ll usually switch to your lender’s Standard Variable Rate (SVR). This rate is often higher than current mortgage rates, which means it’ll cost you more. Some deals may automatically transfer you to another product, while others may change to a tracker product. Know what to expect when your mortgage deal ends. This way, you can make the right choice.

Switch to a new mortgage deal

Changing to a new deal with a different lender is called remortgaging. If you switch to a new deal with your current lender, it’s called a product transfer or product switch.

Choosing a mortgage

When comparing mortgages, it’s important that you look at those you can get. You may not be eligible for all mortgages.

If you see a best buy mortgage that looks too good to be true, check the small print. It might require a large deposit, come with high fees or have strict lending criteria.

Most importantly, make sure you look at mortgages within your loan-to-value or LTV bracket. This is the amount you want to borrow as a proportion of the property’s value. It's a bit technical but really important.

Lenders group their mortgages based on your deposit in relation to the price of the property. The bigger the deposit the better.

Typical loan-to-value (LTV) brackets are:

• 95% for those with at least a 5% deposit
• 90% for those with at least a 10% deposit
• 75% for those with at least a 25% deposit
• 60% for those with at least a 40% deposit.

As a rule of thumb, 95% mortgages have higher interest rates as they represent more risk to the lender.

Lenders offer their best mortgages to borrowers with larger deposits. Those with smaller deposits often pay more due to the higher risk for the lender.

Find out more about loan-to-value ratios in our First time buyer guide (PDF)

Once you know your deposit and the loan-to-value for available mortgages, you need to decide what type of mortgage you want.

Repayment or interest-only?

Lenders charge you interest on your mortgage, so you pay them back more than you originally borrowed.

Some mortgages are taken out on an interest-only basis. But most are taken on a capital repayment basis.

Interest-only mortgages

For an interest-only mortgage, each month you only pay the lender the interest on your debt. The amount you owe remains the same and needs to be repaid at the end of the term.

If you borrow £200,000 over 25 years, you pay the lender monthly interest on that mortgage for 25 years. At the end of the term, you still owe them £200,000.

You repay this borrowing either from your own savings or through a long-term investment designed to clear the mortgage, such as an ISA or an endowment policy. Alternatively, you may be able to sell the property, provided its value is sufficient to repay the outstanding balance and leave funds to support your next steps.

Pros and cons of interest-only mortgages

The pros of interest-only mortgages are:

• you can keep your monthly repayments low since you only pay interest
• you can have improved cashflow

The cons of interest-only mortgages are:

• your mortgage won’t be paid off at the end of the term, so you’ll need to find funds to repay it
• lenders will check if you have a suitable repayment strategy and you must prove this during your mortgage application
• there’s no guarantee you can sell your property for enough to cover the mortgage
• you can’t ensure that an investment will grow enough to pay off your mortgage debt
• over time you’ll pay more interest with an interest-only mortgage than with a capital and interest repayment mortgage

Repayment mortgages

Most mortgages are now taken out on a capital repayment basis, which gives you more certainty.

The lender still charges you interest which you repay every month. But your monthly mortgage repayment also includes a little bit of the sum you originally borrowed.

Month by month you chip away at the original debt. Over your mortgage term, you will have repaid the whole amount borrowed, plus the interest.

Pros and cons of repayment mortgages

The pros of repayment mortgages are:

the certainty that your mortgage will be paid off by the end of your term, as long as you keep up with repayments.

The cons of repayment mortgages are:

your monthly mortgage repayment to the lender may be a little higher than an interest-only mortgage.

Additional borrowing loans

If you want to borrow more, you can take out a further loan secured against your current property. This is an extension of your existing mortgage, rather than a separate type of mortgage.

A further loan can help cover the cost of home improvements or other major projects. If you’re planning improvements that reduce your property’s energy use and could save you money, you may be able to apply for a green loan.

Find out more about our green loans

Mortgage product fees

What is a mortgage product fee?

The majority of lenders offer mortgage products with and without fees. This fee is sometimes called an arrangement fee or completion fee and can be either a flat fee, such as £999, or a percentage of the amount borrowed, such as 1%.

This fee is usually paid at application stage or you can request to add this onto the mortgage account at completion. But if you do this you’ll be charged interest on the fee amount over the full term of your mortgage.

You do not have to choose a product that incurs a fee, however, you may find that interest rates on these products may be lower than products without a fee. It’s important to look at the total cost over the deal period to understand the overall costs and compare deals.

How to work out the total cost of your mortgage over the deal period

The total cost is what you pay for a mortgage, including the monthly repayments and the mortgage fee, over the deal period. For a two-year fixed rate, you should work out the cost over two years. For a five-year deal, work it out over five years.

It’s important to take the fee into account because they can be expensive and affect the overall cost of the mortgage.

A fee-free mortgage might seem appealing, but products with a lower mortgage rate and modest fee could be cheaper overall.

Likewise, the lowest mortgage rate may not be the cheapest overall deal if it comes with a large fee.

The lender uses both the fee and the mortgage rate to create an overall deal. You need to consider both too.

If the mortgage comes with cashback or a free valuation, you should also factor that in when looking at the overall cost.

Next steps

If you need help choosing the right mortgage, you can speak to a mortgage broker who can give you individual mortgage advice, tailored to your finances and individual needs.

We can also help first time buyers achieve their home owning dreams and have a wide range of products to help you buy a home. You'll need to speak to a mortgage broker if you are a first time buyer and want to apply for a mortgage with The Co-operative Bank.

If you can't pay your mortgage

If you’re worried that you won’t be able to pay your mortgage, get in touch with your lender. They will work with you to come up with a repayment plan based on your circumstances.

Find out more

For more information on buying your first home, download our First time buyers guide (PDF).

For more information about mortgages in general, visit our mortgages page.