Choose a mortgage rate and repayment method

Fixed, variable, capped. Flexible, current account, interest only and repayment. Which is for you, asks Mark Battersby?

The UK mortgage market is one of the most sophisticated in the world and there is a plethora of products to consider.

Fixed rates

For cautious borrowers, a fixed rate mortgage may be the solution as you have certainty about your payments over a specified time. Most of the fixed deals set the interest rate for two to five years but be aware that you are going to face a heavy penalty, typically six months' interest, if you exit early. Fixed mortgages also generally cost more than other types and you are still taking a risk because this product takes a call on future interest rates.

Variable rates

At the other end of the spectrum a variable mortgage is nowadays available in a variety of guises. Often, it takes the form of a base rate tracker which follows the Bank of England's interest rate. The interest you pay might, for example, be the base rate plus 0.7% for the length of the mortgage and as Bank of England governor Mervyn King makes a decision each month on where to set interest rates so your mortgage moves in line with this. A discount tracker is a variation which may give you a rate of base rate minus 0.3% for two years and then base rate plus 1% for the rest of the term. This is the most cost effective type of mortgage but if you go for a discounted product you are going to have to keep switching to new deals to get the best value. And what if interest rates soar to 15%? It has happened before.

Capped rates

When interest rates are rising, as they are now, a capped rate may be the solution for homebuyers seeking a security compromise. These mortgages set a ceiling on how much you pay, but will allow the rate to fall again after interest rates peak. One recent offering gave a 1.25% discount on the lender's standard variable rate of 6.54% so you paid 5.29%. But the rate was capped at 5.59% so you will never pay more than that. If interest rates drop in the next two years the rate on this product will also fall.

Flexible mortgages

Flexible mortgages are another twist that, at its core, allow you to overpay or underpay and partly redeem your mortgage without penalty, with interest charged on a daily basis. All the products mentioned so far are available on a flexible basis but remember that these bells and whistles add to the cost and you end up paying for it somewhere.

Current account mortgages

You may also have heard of current account or offset mortgages. These are a refined version of flexible mortgages and the concept is simple enough. Why have a mortgage costing 5.5% interest plus a savings account earning 3.5% when, by offsetting savings against the outstanding mortgage capital, you can save interest at the rate chargeable on the mortgage for the amount by which the savings reduce the capital? In a current account mortgage this is all achieved within one account and when savings are credited the balance falls by the amount of savings. Interest is only charged on the current balance of the account whereas with an offset, mortgages and savings are separate accounts but the savings account earns no interest. Instead, the credit value of savings is offset against the outstanding mortgage capital and interest rate payable reduced accordingly.

Interest only or repayment

The other big decision is whether to go for an interest only or repayment mortgage. Interest only mortgages still require the buyer to find a lump sum to cover the original sum borrowed and ISAs and other regular savings plans can do this job over time given that endowments are a big 'no,no' these days. Repayment loans gradually pay back the loan and the interest so that at the end of the mortgage term everything is paid off.

Whatever you do, always regularly review your mortgage because it is surprising what savings can be made.