Every month, your payments to the lender go towards reducing the amount you owe as well as paying the interest they charge. So each month you're paying off a small part of your mortgage.
The pros: It's a simple, clear approach - you can see your loan getting smaller.
The cons: In the early years your payments will be mainly interest, so if you want to repay the mortgage or move house in the early years, you'll find that the amount you owe won't have gone down by very much.
As the name suggests, your monthly payment only pays the interest charges on your loan - you're not actually reducing the loan itself. This is why it's very important you arrange some other way to repay the loan at the end of the term; for example, through an investment or savings plan.
If you choose this option you will need to check that your investment or savings plan grows accordingly, so that at the end of the term you'll have enough money to pay off the loan. If it doesn't grow as planned, you will have a shortfall and you'll need to think about ways of making this up. See How to make up a shortfall.
The pros: Because you're only paying off the interest, and not the loan itself, your monthly payments will be lower.
The cons: That debt is not going to go away. Throughout the life of the mortgage, you'll need to check your investment or savings plan is on track to repay your loan at the end of the term. If you can't repay it at the end of the term you could lose your home.
Your payments move up or down with the lender's own mortgage rate, which is usually driven by the Bank of England's base rate. Not usually, but check and see.
- Usually you can leave your lender without any penalties or problems.
- You're in control. You can usually pay back extra amounts (and cut your interest costs) without a penalty.
- It moves with interest rates. So if interest rates go up, so will your monthly payment.
- It will almost certainly be expensive compared to other deals.
- The lender may not reduce, or may delay reducing, their variable rate even if the Bank of England rate goes down.
Tracker rate
A variable rate loan with an interest rate that's at a set amount above or below the Bank of England or some other base rate, set independently from the lender. It tracks (moves up or down with) that rate. Sometimes during any special deal period and maybe even after the period too.
- It can pay to go for a tracker if you can afford to pay more when interest rates go up, in exchange for benefiting when they go down.
- It's not a good choice if your budget won't stretch to higher monthly payments.
interest rate Your monthly payments can go up or down, but you get a discount on the lender's standard variable rate for a set period of time. At the end of the deal, you usually change over to the standard variable rate. During the special deal: yes, almost always. They can apply even after the end of the special deal period as well.
- It gives you a gentler start to your mortgage, at a time when money may well be tight. But you must be confident you can afford the payments when the discount ends.
- The discount period is limited, so don't get used to those early low repayments.
- You may not be able to make overpayments and pay off the loan early without penalties
- The lender may not reduce, or may delay reducing their variable rate even if the Bank of England rate goes down.
Your payments are set at a certain level for an agreed period. At the end of that period, they'll usually switch you to the standard variable rate. During the special deal period: yes, almost always. They can apply even after the special deal period, too.
- Your payments will stay the same in that period, even if interest rates go up.
- This gives you the security of knowing that you can afford your payments and will make it easier for you to budget.
- If rates go down, you won't benefit. Your payments will stay at the higher rate.
- You may not be able to make overpayments and pay off the loan early without penalties.
Your payments are variable and often linked to a base rate, but fixed not to go above a set level (the 'ceiling' or 'cap') during the period of the deal. At the end of the period, you are usually charged the lender's standard variable rate. During the special deal: yes, almost always. They can apply even after the end of the special deal period as well.
- You know the maximum you will pay for a set period of time.
- Useful if you want the security of knowing that your payments can't rise above the set level, but still benefit if rates fall.