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Types of Mortgage Loans

A mortgage is a loan used to purchase real estate or property. The majority of contracts are for 25 years, but they can be shorter or longer.

Author:Dexter Cooke
Reviewer:Darren Mcpherson
May 04, 2021
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A mortgage is a loan used to purchase real estate or property. The majority of contracts are for 25 years, but they can be shorter or longer. If the debt is paid off, it is ‘secured' against the value of your house. If you default on your payments, your lender will repossess or take back your home and sell it to recoup their losses.
That pretty much sums up the concept of mortgage loans. And, for your information, mortgages have different types. Don't just look at the interest rate and fees you'll be paying while looking for a mortgage. You should also think about the kind of mortgage you need and want. Basically, there are two mortgage types where you can choose: fixed and variable. Under the variable type, there are five subtypes to consider. Understanding each of them will help you decide better for your home.

Fixed-rate Mortgages 

Whatever happens to interest rates, the interest rate you pay will remain constant for the duration of the loan. This is what fixed-rate mortgages are all about. You'll see terms like 'two-year fix' or 'five-year fix,' along with the interest rate paid during that time span.
What’s great about this type of mortgage is that you'll have peace of mind knowing that your monthly expenses will remain the same, making it easier to budget. However, fixed-rate mortgages are typically marginally more expensive than variable-rate mortgages. You would not benefit if interest rates decline.
There are certain things to watch out for when you avail of a fixed-rate mortgage. If you want to end the contract early, there are fees since you are locked in for the duration of the patch. You can start looking for a new mortgage deal two or three months before the fixed period expires, or you'll be automatically switched to your lender's regular variable rate, which is normally higher.

Variable-rate Mortgages 

In this type of mortgage, the interest rate will change at any time. So, you have to make sure you have enough money set aside to cover any increase in your payments if interest rates rise. Variable-rate mortgages come in a variety of shapes and sizes such as below:

Standard Rate Mortgages 

This is the standard interest rate that your mortgage lender charges homebuyers, and it will last for the duration of your mortgage or until you refinance. Changes in the interest rate can occur as a result of the central bank’s base rate rising or falling.
What’s good about this is that you have complete freedom to overpay or leave at any moment. The only negative thing about standard rate mortgages is that your interest rate can be adjusted at any point during the term of your loan.

Discount Mortgages

This is a reduction in the lender's standard variable rate (SVR) that is only valid for a limited period, usually two or three years. It does, however, pay to shop around. Since SVRs vary by lender, don't assume that a larger discount equals a lower interest rate.
The benefits of getting this mortgage are the lesser cost. The rate starts out lower, resulting in lower monthly payments. You will also pay less per month if the lender lowers its SVR. The disadvantages include budgeting since the lender has the option of increasing the SVR at any time. If the central bank raises interest rates, you should expect the discount rate to rise as well.
You should be careful with this mortgage. If you want to leave before the discount time ends, you will be charged.

Tracker Mortgages 

Tracker mortgages follow another interest rate, typically the central bank's base rate plus a few percentage points. As a result, if the base rate rises by 0.5 percent, the rate will also rise by 0.5 percent. This mortgage usually only lasts two to five years, but some lenders offer trackers that last the duration of your mortgage or until you turn to another contract.
The advantages of tracker mortgages include your mortgage payments decreasing if the rate it is monitoring drop. On the one hand, its advantage is that your mortgage payments would increase if the rate it's monitoring rises. If you want to transfer before the contract expires, you will have to pay an early repayment fee as well. So, Make sure your lender can't raise rates even though the cost to which your mortgage is connected hasn't changed. It's unusual, but it has happened before.

Capped Rate Mortgages 

With capped rate mortgages, your rate moves in line normally with the lender’s SVR. The limit, on the other hand, means that the rate can't go past a certain point. Certainty and affordability are your advantages in this type of mortgage. The rate will not exceed a certain threshold. However, you still have to make sure you can afford repayments if it increases to the cap mark.
If the SVR falls, your rate will drop too. On the contrary, the rate is usually higher than most variable and fixed rates; your lender can adjust the rate at any time up to the amount of the limit.

Offset Mortgages 

These operate by tying your savings and checking accounts to your mortgage, allowing you to pay only the interest on the difference. You continue to pay your mortgage on a monthly basis as normal, but your savings serve as an overpayment, allowing you to pay off your mortgage sooner.

Final Thoughts 

When comparing these offers, keep in mind the fees for canceling them as well as the exit penalties. If you think you'll have trouble making payments, don't go overboard. Consider the ongoing costs of owning a home, such as utility rates, property taxes, insurance, and maintenance. Lenders would want evidence of your profits and any expenses, as well as any debts you might have. They will inquire about household bills, child support, and personal expenditures. Lenders want evidence that you'll be able to make your payments even though interest rates increase. If they don't think you'll be able to afford it, they will refuse to give you a loan.
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Dexter Cooke

Dexter Cooke

Author
Dexter Cooke is an economist, marketing strategist, and orthopedic surgeon with over 20 years of experience crafting compelling narratives that resonate worldwide. He holds a Journalism degree from Columbia University, an Economics background from Yale University, and a medical degree with a postdoctoral fellowship in orthopedic medicine from the Medical University of South Carolina. Dexter’s insights into media, economics, and marketing shine through his prolific contributions to respected publications and advisory roles for influential organizations. As an orthopedic surgeon specializing in minimally invasive knee replacement surgery and laparoscopic procedures, Dexter prioritizes patient care above all. Outside his professional pursuits, Dexter enjoys collecting vintage watches, studying ancient civilizations, learning about astronomy, and participating in charity runs.
Darren Mcpherson

Darren Mcpherson

Reviewer
Darren Mcpherson brings over 9 years of experience in politics, business, investing, and banking to his writing. He holds degrees in Economics from Harvard University and Political Science from Stanford University, with certifications in Financial Management. Renowned for his insightful analyses and strategic awareness, Darren has contributed to reputable publications and served in advisory roles for influential entities. Outside the boardroom, Darren enjoys playing chess, collecting rare books, attending technology conferences, and mentoring young professionals. His dedication to excellence and understanding of global finance and governance make him a trusted and authoritative voice in his field.
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