Fixed rate or variable? The different types of mortgages

There are lots of different mortgage deals out there, but mostly, they fall into two different categories: fixed rate and variable rate.

Here, ‘rate’ refers to the interest rate you have on your mortgage. The interest rate is what determines how much interest you pay, on top of repaying the amount you’ve actually borrowed (aka ‘the capital’).

Each rate will run for a set period, eg 2 or 5 years (though you can get rates than run over the whole term of your mortgage, like a lifetime tracker rate). At the end of the period, the lender will automatically switch you to their standard variable rate, or SVR. SVR is basically the lender’s own rate – they can set it as high or as low as they like, and increase it whenever they want to.

It usually comes with no ‘early repayment charge’ (a fee for for switching to another rate, paying more of your mortgage each month, or paying off your mortgage early). But for many first time buyers, that’s not enough to balance out the cost and lack of security. If you’re headed towards an SVR, it’s almost always worth looking at remortgaging.

Fixed rate mortgage

The interest you pay on your loan is ‘fixed’ – guaranteed to stay the same – for a period of time. This period can range from 2 to 10 years. During that time you know exactly what your monthly payments will be.

Almost all fixed rate mortgages come with an early repayment charge during the time that your rate is fixed. Your broker can help you decide what’s worth doing.

At the end of the period, you’ll automatically be switched to a standard variable rate (SVR). Usually, a few months before the end of your period, your lender will typically write to you to offer an alternative. You could also speak to a broker to see if they can find you a better deal with another lender.

Tracker mortgage (variable)

Tracker rates work by tracking – as you might have guessed – a particular interest rate, usually the Bank of England base rate, and adding a certain amount on top.

With a tracker mortgage, your monthly repayments will rise and fall as the interest rates do. So if the base rate goes up, your payments go up. If interest rates go down, so will your payments. You’ll need to consider how you’ll budget for increases in mortgage payments – your broker can help you with this.

Discounted rate mortgages (variable)

A discounted rate mortgage gives you a discount on your lender’s standard variable rate (SVR) for a fixed period, usually 2, 3 or 5 years.

They’re not the same as fixed rate mortgages. They’re still tied to the SVR, so if your lender raises interest even a little, that can increase your monthly repayments. And unlike a SVR, they usually do include a fee for paying off your mortgage early or remortgaging, though only during the discounted period.

The total cost of a mortgage

Interest rates alone can’t tell you which mortgage is cheaper. That’s because a mortgage might have a lower rate, but end up costing more because of fees. So when we talk about the ‘total cost’ of a loan, we’re factoring in the interest rate, fees, incentives – all the money you have to pay the lender, usually assessed over the first fixed period of the term.

Let’s say you want to borrow £250,000 over 25 years, and you’re comparing loans from two different lenders.

See how even though the first interest rate looks lower, it’s actually a higher total cost over a 2 year fixed period: