3.2 Different types of mortgage interest
The other two main ways in which mortgage products vary are in:
- whether the interest on the loan varies (variable interest mortgage) or not (fixed-interest mortgage)
- the way payments are made and offset and can be changed.
Box 2 outlines the main options available.
Box 2 Main mortgage interest and payment variations
- Standard variable rate mortgage: The rate of interest goes up and down broadly in line with movements in the official rate set by the country’s central bank.
- Tracker mortgage: Variable rate mortgage where the interest rate is guaranteed to be a specified amount above an ofﬁcial rate and automatically adjusts when that rate changes.
- Discounted rate mortgage: Variable rate mortgage which offers a discount to the standard variable rate for an initial period.
- Fixed rate mortgage: The interest rate is ﬁxed at a specified rate for a period of years whatever happen to official interest rates. Borrowers know exactly what their mortgage expenditure will be for several years ahead. Typically there is a fee if the borrower wants to pay off this mortgage early.
- Capped rate mortgage: The interest rate is variable but cannot exceed a maximum level. These products also have early repayment fees.
- Flexible mortgage: Variable rate repayment mortgage which may provide a number of payment options, including being able to overpay, underpay, re-borrow amounts previously overpaid or suspend payments for a while. It can be especially useful for borrowers whose income tends to vary – for example, the self-employed.
- Offset mortgage: A cash balance in a current account or savings accounts with the same provider is deducted from (‘offset’ against) the outstanding mortgage debt before the monthly mortgage interest is worked out. No interest is paid on the current account or savings account, but offsetting reduces the amount of interest charged on the mortgage.
- Family offset mortgage: As above, but family members – usually parents – provide the savings account that is offset against their son’s or daughter’s mortgage.
- Shared ownership mortgages: The borrower buys just part of their home, reducing the size of mortgage needed. The rest is typically owned by a social landlord, to whom the householder pays rent. The aim is that the sum of the mortgage payments and rent is lower than mortgage payments would have been for buying the whole property.
Activity 6 A recap of mortgage types
Thinking about the two main types of mortgage (repayment and interest-only) and the variations described in Box 2, drag and drop the types of mortgage and interest payments into their matching brief description.
The decision about which type of interest rate to choose depends partly on a person’s attitude towards risk in budgeting and their capacity to cope with changes in their level of spending. For example, some people may prefer a fixed-rate mortgage even if the rate seems a little high rather than gambling on the likely direction of movement of a variable rate. In some countries, fixed rates over terms as long as 25 years are common, and gambling on variable rates is seen as far too risky. The decision may also depend on expectations about the future state of one’s finances. There is always a range of factors to consider in making such a big decision.