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Mortgage types

The UK mortgage market is one of the most innovative and competitive in the world. Unlike other countries there is no intervention in the market by the state or state funded entities and virtually all borrowing is funded by either mutual organisations (building societies and credit unions) or proprietary lenders (typically banks). Since 1982, when the market was substantially deregulated, there has been substantial innovation and diversification of strategies employed by lenders to attract borrowers. This has led to a wide range of mortgage types.

As lenders derive their funds either from the money markets or from deposits, most mortgages revert to a '''variable rate''', either the lender's '''standard variable rate''' or a '''tracker rate''', which will tend to be linked to the underlying Bank of England (BoE) repo rate (or sometimes LIBOR). Initially they will tend to offer an ''incentive deal'' to attract new borrowers. This may be:

* A '''fixed rate'''; where the interest rate remains constant for a set period; typically for 2, 3, 4, 5 or 10 years. Longer term fixed rates (over 5 years) whilst available, tend to be more expensive and/or have more onerous early repayment charges and are therefore less popular than shorter term fixed rates.

* A '''capped rate'''; where similar to a fixed rate, the interest rate cannot rise above the ''cap'' but can vary beneath the cap. Sometimes there is a '''collar''' associated with this type of rate which imposes a minimum rate. Capped rate are often offered over periods similar to fixed rates, e.g. 2, 3, 4 or 5 years.

* A '''discount rate'''; where there is set margin reduction in the standard variable rate (e.g. a 2% discount) for a set period; typically 1 to 5 years. Sometimes the discount is expressed as a margin over the base rate (e.g. BoE base rate plus 0.5% for 2 years) and sometimes the rate is stepped (e.g. 3% in year 1, 2% in year 2, 1% in year three).

* A '''cashback''' mortgage; where a lump sum is provided (typically) as a percentage of the advance e.g. 5% of the loan.

To make matters more confusing these rates are often combined: For example, 4.5% 2 year fixed then a 3 year tracker at BoE rate plus 0.89%.

With each incentive the lender may be offering a rate at less than the market cost of the borrowing. Therefore, they typically impose a penalty if the borrower repays the loan within the incentive period or a longer period (referred to as an ''extended tie-in''). These penalties used to be called a ''redemption penalty'' or ''tie-in'', however since the onset of Financial Services Authority regulation they are referred to as an '''early repayment charge'''.