Choosing the Right Mortgage.

Choosing a mortgage is one of the most important financial decisions associated with buying or refinancing a property. The interest-rate arrangement you select can affect your monthly payments, your ability to budget, and your total borrowing costs for many years.

A low initial interest rate is not necessarily the cheapest mortgage overall. Arrangement fees, valuation costs, early repayment charges, incentives, the length of the introductory period and the rate payable afterwards must all be considered.

This guide explains the main differences between fixed-rate, tracker and discounted-variable mortgages. It provides general information and is not a personal mortgage recommendation.

Understanding Mortgage Interest Rates

Mortgage interest is charged on the amount borrowed. The rate can be fixed for an agreed-upon period or variable, meaning it can change over the life of the mortgage.

Several different interest rates are relevant to the mortgage market:

• Bank Rate, set by the Bank of England;
• a lender's standard variable rate;
• a tracker rate linked to a stated benchmark;
• a discounted rate set below another variable rate; and
• a fixed rate that remains unchanged for an agreed period.

The Bank Rate influences borrowing costs across the economy, but it is not the interest rate that most mortgage customers pay. Lenders also consider funding costs, commercial margins, competition, risk and the characteristics of the borrower and property.

What Is Bank Rate?

Bank Rate is the principal interest rate set by the Bank of England. Changes in Bank Rate can influence mortgage, loan and savings rates, but lenders do not have to move every mortgage product by the same amount unless the mortgage contract expressly links the rate to Bank Rate.

A change in Bank Rate may therefore affect different borrowers in different ways:

• a borrower on a Bank Rate tracker may see a direct change;
• a borrower on a discounted rate may only see a change if the lender alters its standard variable rate;
• a borrower on a standard variable rate may see a change determined by the lender; and
• a borrower within a fixed-rate period will normally see no immediate change.

What Is a Lender's Standard Variable Rate?

A standard variable rate, commonly called an SVR, is an interest rate set by the mortgage lender.

The lender may change its SVR in accordance with the mortgage terms. Although SVRs often respond to changes in Bank Rate and broader market conditions, they are not typically contractually required to match movements in Bank Rate exactly.

Many borrowers move onto the lender's SVR automatically when a fixed, tracker or discounted introductory deal ends, unless they arrange another mortgage product.

An SVR may offer greater flexibility and may have no early repayment charge. Still, it is commonly higher than the lender's introductory mortgage rates. It can change at relatively short notice.

What Is a Fixed-Rate Mortgage?

A fixed-rate mortgage provides an agreed interest rate for a specified period. Common fixed periods include two, three, five or ten years, although other terms may be available.

For example, if a mortgage is fixed at 4.5% for five years, the interest rate will normally remain at 4.5% throughout that period regardless of changes in Bank Rate or the lender's SVR.

Where the mortgage is on a repayment basis, the monthly payment should usually remain stable during the fixed period, provided there are no changes to the loan balance, term or other relevant arrangements.

Advantages of a Fixed-Rate Mortgage

A fixed-rate mortgage may provide:

• certainty about the interest rate;
• stable monthly payments during the fixed period;
• protection against interest-rate increases;
• easier household budgeting; and
• greater reassurance for borrowers with limited spare income.

The certainty can be valuable where even a relatively small increase in monthly payments would place pressure on the household budget.

Disadvantages of a Fixed-Rate Mortgage

Potential disadvantages include:

• no automatic benefit if variable rates fall;
• early repayment charges during the fixed period;
• limits on penalty-free overpayments;
• potentially higher initial rates than some variable deals;
• arrangement or product fees; and
• the risk of moving onto a higher SVR when the fixed period ends.

A fixed mortgage is not necessarily fixed for the entire mortgage term. The introductory rate may end after two or five years, even though the mortgage itself continues for 20, 25, 30 or more years.

What Happens When a Fixed Rate Ends?

When a fixed-rate period ends, the mortgage will usually move onto the lender's SVR unless the borrower:

• selects another product from the same lender;
• remortgages to a different lender;
• repays the mortgage; or
• agrees another arrangement.

Borrowers should normally review their options before the fixed period expires. Remaining on the SVR may be appropriate in some circumstances, but it may result in a substantially higher monthly payment.

A new mortgage may be reserved several months before the current deal ends, subject to the lender's rules, affordability requirements and the validity period of the offer.

What Is a Tracker Mortgage?

A tracker mortgage is a variable-rate mortgage linked to a specified external or lender-controlled benchmark. Many tracker mortgages follow Bank Rate plus or minus an agreed margin.

For example, a tracker set at Bank Rate plus 1% would charge:

• 4% if Bank Rate were 3%;
• 5% if Bank Rate rose to 4%; and
• 3% if Bank Rate fell to 2%.

The precise wording of the mortgage offer is important. Not every product described as a tracker necessarily follows Bank Rate, and the contract may contain a minimum rate below which the mortgage cannot fall.

Advantages of a Tracker Mortgage

A tracker may offer:

• a transparent link between the mortgage rate and the stated benchmark;
• lower payments if the tracked rate falls;
• competitive initial pricing;
• greater flexibility on some products; and
• no early repayment charge on certain lifetime trackers.

Disadvantages of a Tracker Mortgage

Potential disadvantages include:

• monthly payments increasing when the tracked rate rises;
• less certainty for household budgeting;
• early repayment charges on some products;
• a collar or minimum interest rate;
• a margin that changes after an introductory period; and
• the possibility that future fixed rates become more expensive before the borrower switches.

A tracker mortgage is not a guarantee of being cheaper than a fixed-rate deal. The final cost depends on the starting rate, fees and how the tracked benchmark moves during the relevant period.

What Is a Discount Mortgage?

A discount mortgage is normally a variable-rate mortgage offering a stated reduction from another rate, commonly the lender's SVR, for an agreed period.

For example, if the lender's SVR is 6.5% and the mortgage provides a two-percentage-point discount, the payable rate will be 4.5%.

If the lender increases its SVR to 7%, the mortgage rate will usually increase to 5%. If the lender reduces its SVR to 6%, the mortgage rate will normally fall to 4%.

The size of the discount does not by itself show which mortgage is cheapest. A 2% discount from an SVR of 7% produces a higher rate than a 1% discount from an SVR of 5.5%.

Advantages of a Discount Mortgage

A discounted mortgage may provide:

• a relatively low introductory rate;
• lower initial monthly payments;
• the possibility of lower payments if the lender reduces its SVR; and
• greater flexibility than some fixed-rate products.

Disadvantages of a Discount Mortgage

Potential disadvantages include:

• the lender controlling the underlying SVR;
• payments increasing if the SVR rises;
• no guarantee that the SVR will fall when Bank Rate falls;
• early repayment charges;
• a higher reversion rate when the discount ends; and
• less certainty than a fixed-rate mortgage.

A borrower should check whether the discount is fixed for the introductory period. Some products provide a discount that reduces or changes in stages.

Are Discount Mortgages the Same as Tracker Mortgages?

No. Both are variable-rate products, but the underlying mechanism is different.

Tracker Mortgage

A tracker normally follows a stated rate according to a contractual formula, such as Bank Rate plus 1%.

Discount Mortgage

A discount mortgage typically offers a reduction off the lender's SVR. The lender controls the SVR and may not change it by the same amount or at the same time as the Bank Rate.

The mortgage documentation should identify:

• the rate being tracked or discounted;
• the margin or discount;
• how and when changes take effect;
• whether a minimum rate applies;
• the length of the arrangement; and
• the rate payable afterwards.

Can a Mortgage Be Both Discounted and Tracked?

Some mortgage descriptions combine different features. A lender might offer a temporary reduction from its ordinary tracker margin or another introductory arrangement linked to a benchmark.

For example, the lender's standard tracker might be Bank Rate plus 2%, while an introductory product reduces that margin by 0.75% for two years. During that period, the borrower would pay Bank Rate plus 1.25%.

Marketing terminology should not be relied upon on its own. The mortgage offer and the European Standardised Information Sheet, or an equivalent product information document, should explain the actual calculation.

Fixed Rate or Variable Rate: Which Is Better?

no mortgage type is best for every borrower. The appropriate arrangement depends on the borrower's financial position, attitude to uncertainty and plans.

A Fixed Rate May Be More Suitable Where:

• stable monthly payments are a priority;
• the borrower has limited capacity to absorb an increase;
• the household needs certainty for budgeting;
• the borrower expects to remain in the property throughout the fixed period; or
• protection against rising rates is considered more important than benefiting from possible falls.

A Tracker or Discounted Rate May Be More Suitable Where:

• the borrower can afford increases in monthly payments;
• flexibility is important;
• the product has low or no early repayment charges;
• the borrower intends to make substantial overpayments;
• the mortgage may be repaid or changed relatively soon; or
• the borrower accepts the uncertainty associated with variable rates.

Choosing a variable rate solely because interest rates are expected to fall can be risky. Economic forecasts can change, and mortgage pricing may reflect anticipated future movements in Bank Rate before a change occurs.

Test Whether You Could Afford Higher Payments

Before selecting a variable-rate mortgage, consider how the household budget would be affected if interest rates increased.

A borrower should examine whether payments would remain affordable following increases of:

• one percentage point;
• two percentage points; and
• three percentage points or more.

The effect will depend on the mortgage balance, remaining term and repayment method.

Affordability should include more than the ability to make the first payment. Consider income stability, childcare, utilities, insurance, maintenance, unsecured borrowing and the possibility of temporary illness, unemployment or reduced earnings.

Compare the Total Cost, Not Just the Interest Rate

A mortgage with a lower interest rate can cost more overall if it has a large product fee or other charges.

When comparing mortgages, consider:

• the monthly payment;
• the interest rate;
• the length of the introductory deal;
• the product or arrangement fee;
• valuation fees;
• legal fees;
• broker fees;
• cashback or other incentives;
• early repayment charges;
• overpayment limits;
• the rate payable after the deal ends; and
• the total amount payable over the comparison period.

Adding a product fee to the mortgage avoids paying it immediately, but interest may be charged on that fee for the remaining term of the mortgage unless it is repaid earlier.

Annual Percentage Rate of Charge

The Annual Percentage Rate of Charge, usually shown as APRC, is intended to illustrate the overall annual cost of the mortgage using specified assumptions.

It can assist with comparison, but it should not be used in isolation. The calculation may assume that the borrower keeps the mortgage for its full term and remains on the reversion rate after the introductory deal ends.

Many borrowers remortgage or select a new product when the initial rate ends, so the APRC may not reflect what they ultimately pay.

Early Repayment Charges

An early repayment charge, or ERC, may be payable if the borrower:

• repays the mortgage early;
• remortgages during the deal period;
• switches to another product;
• sells the property and cannot transfer the mortgage; or
• makes overpayments above the permitted allowance.

The charge may be calculated as a percentage of the outstanding mortgage balance and may reduce as the end of the deal approaches.

For example, an ERC of 3% on an outstanding balance of £200,000 would amount to £6,000.

A borrower should check:

• when the ERC starts and ends;
• whether it reduces each year;
• whether it applies to the full balance or only the amount repaid;
• the permitted annual overpayment;
• whether the mortgage is portable; and
• whether any extended tie-in continues after the introductory rate ends.

Extended tie-ins beyond the discounted period are less common than they once were, but the mortgage terms must still be checked.

Overpayments

Overpaying a mortgage repayment can reduce the outstanding balance, future interest, and the time required to repay the loan.

Many fixed-rate deals allow limited penalty-free overpayments, often calculated as a percentage of the balance each year. The precise allowance differs between lenders and products.

Some variable mortgages permit larger overpayments without an ERC. This may make a slightly higher-rate product more suitable for a borrower expecting to repay a large lump sum.

Before overpaying, consider whether:

• an emergency savings reserve is available;
• more expensive debts should be repaid first;
• the mortgage has an ERC or overpayment limit;
• the payment will reduce the term or monthly payment;
• the money may be needed in the near future; and
• pension or other financial priorities should be considered.

Porting a Mortgage

A portable mortgage may be transferred to another property when the borrower moves home, subject to the lender's approval.

Portability does not guarantee that the lender will permit the transfer. The borrower will normally need to make a new application and satisfy the lender's current:

• affordability assessment;
• income requirements;
• credit criteria;
• loan-to-value limits; and
• property requirements.

If additional borrowing is required, that portion of the mortgage may be offered at a different rate and end date. This can make future remortgaging more complicated.

Loan-to-Value

Loan-to-value, commonly abbreviated as LTV, compares the mortgage balance to the property's value.

For example, a £180,000 mortgage on a property worth £240,000 represents an LTV of 75%.

Lenders commonly offer different rates according to LTV bands. A lower LTV may provide access to a wider range of products or lower interest rates because the lender is exposed to less risk.

A larger deposit or repayment that reduces the mortgage to a lower LTV band may therefore affect the rates available.

Repayment and Interest-Only Mortgages

The interest-rate arrangement is separate from the method used to repay the mortgage.

Repayment Mortgage

Each monthly payment includes interest and repayment of part of the capital. If all payments are made, the mortgage should be repaid by the end of the term.

Interest-Only Mortgage

The monthly payment normally covers interest but does not repay the amount borrowed. The borrower must have a credible strategy for repaying the capital at the end of the term.

Fixed, tracker and discounted rates may potentially be offered on either repayment method, depending on the lender's criteria.

Fees and Incentives

Mortgage offers may include:

• free or reduced valuation fees;
• free standard legal work for a remortgage;
• cashback;
• no product fee;
• a booking fee;
• a product or arrangement fee; and
• a higher lending charge.

An incentive should not be treated as free money without examining the interest rate and other costs. A fee-free product with a higher rate may cost more over the term of the deal than a lower-rate product with a fee, particularly for a larger mortgage.

Remortgaging

Remortgaging means replacing an existing mortgage, usually with a new mortgage from another lender.

A borrower may remortgage to:

• obtain a lower rate;
• avoid moving onto an SVR;
• change from variable to fixed interest;
• change the mortgage term;
• borrow additional money;
• remove or add a borrower; or
• obtain more suitable repayment or overpayment terms.

The potential saving should be compared with:

• the existing ERC;
• new product fees;
• valuation and legal costs;
• broker charges;
• the new interest rate;
• the remaining mortgage term; and
• the time required to recover the switching costs.

Product Transfers

A product transfer involves moving to a different mortgage rate with the existing lender without replacing the underlying lender.

It may involve less paperwork and may not require a new property valuation or full affordability assessment in every case. However, the lender's own products may not be the most competitive or suitable products available in the wider market.

A borrower should compare product transfers with remortgaging options rather than assuming that remaining with the existing lender is the cheapest option.

What If You Expect Interest Rates to Fall?

A borrower expecting rates to fall might consider a tracker, a discounted mortgage, or a shorter fixed period. However, future rate changes cannot be predicted with certainty.

Fixed mortgage pricing is influenced by lenders' expectations, wholesale funding costs, and the current Bank Rate. Fixed rates can therefore rise or fall before the Bank of England changes Bank Rate.

The relevant question is not simply whether rates may fall, but:

• how far and how quickly they may fall;
• whether the potential saving exceeds any higher initial cost;
• whether the borrower can withstand an unexpected increase;
• whether switching later would involve an ERC; and
• how long the borrower expects to keep the mortgage.

What If You Expect Interest Rates to Rise?

A fixed-rate mortgage can protect the borrower from increases during the fixed period. However, the cost of anticipated increases may already be reflected in the fixed rate being offered.

A long fixed period provides greater certainty but can also extend the ERC period. A borrower expecting to move, repay a large sum or change circumstances should consider whether that loss of flexibility is acceptable.

Questions to Ask Before Selecting a Mortgage

Before accepting a mortgage, ask:

• is the interest rate fixed or variable;
• what rate or benchmark controls any changes;
• how long does the introductory arrangement last;
• what rate applies afterwards;
• what are the monthly payments now;
• what would the payments be if rates increased;
• what fees are payable;
• can the fees be added to the loan;
• what early repayment charges apply;
• how much can be overpaid without a charge;
• is the mortgage portable;
• can payment holidays or term changes be requested;
• what happens if the property is sold;
• does the adviser consider the whole market or a limited panel; and
• how is the adviser paid?

Mortgage Advice and Regulation

Advice recommending a particular regulated residential mortgage is generally a regulated financial activity. Mortgage brokers must usually be authorised by the Financial Conduct Authority or act as an appointed representative of an authorised firm.

A regulated mortgage adviser should consider matters including:

• income and expenditure;
• financial commitments;
• deposit and loan-to-value;
• credit history;
• expected changes in circumstances;
• attitude to payment uncertainty;
• desired flexibility;
• the intended length of ownership; and
• the borrower’s stated needs and priorities.

Borrowers should check the firm on the Financial Services Register and confirm that it has permission to provide the service.

Independent Mortgage Advice and Legal Advice

A mortgage broker or financial adviser can recommend and arrange a mortgage within the scope of their services.

A conveyancing solicitor handles the legal work involved in a mortgage and property transaction. The solicitor will normally:

• review the mortgage offer;
• explain the legal mortgage conditions where required;
• investigate title to the property;
• report relevant issues to the lender;
• complete the mortgage deed;
• request and account for mortgage funds; and
• register the lender's legal charge.

A conveyancing solicitor does not normally provide regulated financial advice about whether a fixed, tracker or discounted mortgage is the most suitable product unless separately authorised to do so.

Difficulty Paying the Mortgage

A borrower concerned about making mortgage payments should contact the lender promptly rather than waiting for arrears to grow.

Depending on the circumstances, possible arrangements may include:

• extending the mortgage term;
• temporarily changing the payment arrangement;
• switching temporarily to interest-only payments where available;
• agreeing repayment of arrears over time;
• selecting another mortgage product; or
• selling the property in a controlled manner.

Any change can affect the total amount of interest paid and should be understood before it is accepted.

Fixed-Rate and Variable Mortgage Summary

Fixed-Rate Mortgage

A fixed rate provides payment certainty and protection from rate increases during the agreed period. Still, it may prevent the borrower from benefiting from falling rates and commonly includes early repayment charges.

Tracker Mortgage

A tracker follows an identified rate according to a contractual formula. Payments can rise or fall, and the borrower should understand any margin, collar and early repayment charge.

Discount Mortgage

A discounted mortgage provides a reduction from another variable rate, commonly thelender'ss SVR. The rate can change when the underlying rate does, and the lender generally controls its SVR.

Standard Variable Rate

An SVR is set by the lender and can change.

It may offer flexibility but is frequently more expensive than introductory deals.

Finding Professional Mortgage Advice

The choice between a fixed, tracker, and discounted mortgage should be based on the full product terms, not on a prediction about interest rates or an attractive headline figure.

Consider the monthly payment, total cost, fees, early repayment charges, flexibility, plans and ability to manage an unexpected rate increase.

Before accepting a mortgage, consider obtaining advice from an appropriately authorised mortgage adviser and from a conveyancing solicitor regarding the property and mortgage documentation.

This guide provides general information about UK residential mortgages. It does not constitute financial or legal advice or a recommendation to enter into a particular mortgage.