Mortgages explained: what are some of the most common types?

'Mortgages explained' is a popular search term, and it’s no wonder. Figuring out the best mortgage products for you requires careful research and advice. With this in mind, we always recommend seeking independent and professional financial advice. We must also state that the following explanations are in summary form only and do not constitute financial advice. Our goal is simply to help you make sense of some of the most common mortgage products out there.

Repayment mortgages explained

Repayment mortgages are the most common types of mortgages. They are used by the majority of new homeowners to buy the property in which they plan to live. It is a mortgage product that requires you to pay some of the ‘capital’ (the amount you borrowed) along with some of the interest each month. As long as you keep up with your monthly payments, you will have repaid the loan in full by the time you reach the end of your mortgage term.

In the first few years of your mortgage term, the repayments cover a larger amount of interest than they do capital. Over time, the balance shifts and you begin to pay off more capital than interest.

Within this bracket of mortgages there are several types that you can choose from, each offering its own list of benefits and risks. We would always advise seeking professional financial advice before deciding on which is right for you.

Buy-to-let mortgages explained

A ‘buy-to-let mortgage’ allows you to buy a property that you intend to let out to tenants.

The rules around these types of mortgages differ to those around repayment mortgages. They are widely considered to be higher risk by lenders, for example, meaning you may need to match certain criteria to be eligible. Although these vary from lender to lender, common requirements include.

-That you already own your own home (either outright, or with a mortgage)

-That you have good credit and are not overstretched with other debt

-That you are able to provide evidence of income separate from rental earnings

-That you are below a set age threshold

-A minimum deposit of 25% (many lenders offer a maximum Loan-to-Value (LTV) limit of 75%)

-A minimum expected rental income amount over the monthly mortgage payments. For example, your lender may require a minimum expected rental income to cover 125% of your mortgage payments.

Many buy-to-let mortgages are interest only, meaning you only pay the interest on the loan each month and not the capital. The original loan amount is paid in full at the end of the mortgage term. It’s worth noting that interest rates on buy-to-let mortgages are usually higher, and that the fees to get a buy-to-let mortgage tend to be higher, too.

Borrowing for a buy-to-let mortgage is linked to the amount of rent you expect to receive. You’ll usually need to expect rental payments to cover the mortgage payments, plus extra. If rental income is lower than required, your lender may reduce the LTV, meaning you would need to pay a larger deposit.

Interest only mortgages explained

An interest only mortgage is a loan on which the borrower pays only the interest. The full amount will not be due until the end of the mortgage term, at which time it must be repaid.

Buy-to-let mortgages are often taken in the form of interest only loans. They equate to smaller monthly payments for the duration of the loan term. When the loan term ends, you must pay the original loan amount in full.

Interest only mortgages aren’t for everybody. But they may prove a handy option for those with a clear, safe plan for the eventual loan repayment. This could be in the form of safe investments, or a promise of future income or a windfall. To be eligible, you will need to prove your ability to pay the full amount at the end of the mortgage term.

With an interest only mortgage, monthly payments are smaller than those of a repayment mortgage. But you usually end up paying more interest in total. With a repayment mortgage, the amount of interest you pay over time decreases. With an interest only mortgage, the interest rate doesn’t decrease. You will have to pay the full, original amount back as well, increasing the total amount paid for the loan.

Retirement Interest Only mortgages explained

A retirement interest only mortgage is only available on your main residence. It is similar to a standard interest only loan, with two main differences.

The first difference is that the loan is usually only paid off when you die, move into long-term care, or sell the property.

The second difference is that you only need to prove your ability to pay the monthly interest payments. You don’t need to prove your ability to pay the full balance at the end of the term.

Retirement interest only mortgages are generally aimed at older borrowers. This is because they may find it easier to qualify for this particular product over a typical interest only mortgage.

Lifetime mortgages explained

A lifetime mortgage is a loan that’s secured against your home. The full amount does not need to be repaid until you die or go into long-term care. With a lifetime mortgage, interest is charged on the amount you have borrowed. This can be repaid or added on to the total loan amount. When the last borrower dies or moves into long-term care, the property is sold and the money used to pay off the loan. If there isn’t enough money left from the sale to cover the remaining balance, your beneficiaries may be required to repay any extra above the value of your home from your estate. Most lifetime mortgages offer a no-negative-equity guarantee to guard against this. Through this guarantee, the lender promises that neither you, or your beneficiaries, will have to pay back more than the value of your home.

For the duration of the loan, your home still belongs to you. What it enables you to do is free up some of the wealth you have tied up in it, whilst allowing you to continue living there.

There are two forms of Lifetime Mortgage: Interest Roll-Up, and Interest Paying. An Interest Roll-Up mortgage is paid to you in either a lump sum, or in regular amounts. You are charged interest which is added to the loan. This means you needn’t make any regular payments. The amount you borrow, including the rolled-up interest, is repaid when your home is sold.

Be aware of compounding interest. In the first year, interest is only charged on the original loan amount. However, in years thereafter, interest is also charged on the amount of interest accumulated in previous years. This means an increased interest rate, year on year.

An interest-paying mortgage is also paid in either a lump sum or in regular payments. However, the borrower is able to make either monthly or ad-hoc interest payments. This can reduce, or even stop, the impact of interest roll-up.

Equity Release: Home Reversion explained

We have already covered one Equity Release option in our ‘Lifetime Mortgages Explained’ section. The second option is Home Reversion.

Home reversion is a product that allows you to sell part or all of your home to a home reversion provider. This is done in return for either a lump sum or regular payments. As the borrower, you retain the right to continue living in the property until you die. You must, however, agree to maintain and insure it.

If you choose to, you can ‘ring fence’ a percentage of your property for later use by only selling a part of it. This could help ensure you leave an inheritance for your beneficiaries. When the last borrower dies or moves into long-term care, the property is sold. Once sold, the sale proceeds are shared according to the percentages owned by each party.

If you’re on the hunt for a new property, be it to live in or as an investment, then hopefully the above gives some insight into the mortgages that might be available to you. And if you are actively searching for property, then why not click here and see what’s currently on the market?