Mortgage Types And Rates For Bad Credit

In this guide, we’ll explore the different types of mortgages and interest rates that could be available to you if you have a history of bad credit.

The different ways of repaying your mortgage

When it comes to paying back your mortgage, there’s two ways you can do it: ‘repayment’ or ‘interest-only’. Most residential mortgages are capital repayment, but for buy-to-let purposes, interest-only mortgages tend to be the most popular choice.

What is a repayment mortgage?

Most homeowners have a repayment mortgage. Essentially, each monthly repayment will chip away at both your mortgage and the interest owed. At the end of your mortgage term, you’ll have paid off everything - the original amount you borrowed plus the interest.

When you first start making your repayments, the bulk of the money will go towards paying off the interest. But this isn’t a reason to be concerned. The interest on mortgages is known as ‘front-loaded’, which means you're paying more interest at the start.

Simply put, your interest is calculated on how much money you have left to pay back, so the interest will remain high until you start chipping away at your outstanding balance. The more you pay off, the less interest you'll be paying.

What is an interest-only mortgage?

It’s as it says. With an interest-only mortgage, you’re only paying off the interest on your loan each month, rather than paying back the money you’ve borrowed. So at the end of your mortgage term, you’ll still have the entire loan to pay back. 

The reason people opt for interest-only is because the monthly repayments are a lot lower. It’s not a hugely common option for homeowners because it’s only cost-effective in the short term - you’ll still have to pay off the lump sum at the end of your mortgage term. Most people who opt for interest-only mortgages have chosen this for their buy-to-let properties. 

Choosing your mortgage interest type

Along with choosing how you pay back your mortgage, you’ll also need to consider the interest type. There’s a few different ones, and they can all affect your mortgage differently.

Fixed Rate

Fixed rate mortgages are very popular in the UK. Fixed Rate means the amount of interest you’ll pay won’t change for a fixed amount of time. Typically, this is between two and five years. When your fixed rate deal ends, your interest rate will switch to your mortgage lender’s ‘standard variable rate’ (SVR). 

If you want a longer fixed rate deal, you’ll normally have to pay a higher level of interest. When your deal is up, you have the option to remortgage.

Fixed rate pros:

• You know exactly what your repayments will be every month.

• Your mortgage interest will stay the same, even if rates increase.

Fixed rate cons:

• If interest rates drop, you won’t benefit from the lower rate.

• If you want to repay your mortgage early, you’ll usually have to pay an early repayment charge (ERC).

Standard Variable Rate (SVR)

A mortgage lender’s ‘standard’ rate with no discounts attached. The SVR is the rate used once your current mortgage deal comes to an end and is usually the highest rate across the lender’s product range. Not one you want to stay on for too long.

SVR pros:

• You don’t have to stick with this rate, it’s usually for when a different deal comes to an end.

• You usually won’t pay a penalty if you pay off your mortgage early. ‍

SVR cons:

• If interest rates shoot up, your repayments could become very expensive.

• If your repayments become more than you can afford, your home could be at risk.

Tracker Rate

A tracker rate is a variable interest rate that tracks another interest rate, typically the Bank of England's base rate, for a set period of time. So, the repayments on a tracker rate mortgage can rise and fall in line with the Bank of England’s base rate.

Tracker pros:

• Your repayments will go down if interest rates drop.

• You could get a good introductory deal, as trackers are riskier than other mortgages.

Tracker cons:

• Your repayments will increase if interest rates go up, making budgeting more difficult.

• Some tracker mortgages set certain lower limits (known as collar rates) meaning you won’t benefit from really low payments if rates drop below this limit.

Discount Rate

A type of variable rate, discount rate mortgages have a fixed interest rate set lower than your lender’s SVR for a period of time. Essentially a ‘discounted’ rate. 

Discount Rate pros:

• You can grab a low interest rate at the right time.

• Your arrangement fee may be lower.

Discount Rate cons:

• Your rate could change at any time, making budgeting more difficult.

• Just because the Bank of England changes their base rate, doesn’t mean your lender will change theirs. You might also have a cap on how low your repayments can go.

Capped Rate

Capped rate mortgages are a form of Variable Rate mortgage. However, they have an upper limit - or cap - for how much the interest rate can increase. They’re fairly rare these days.

Capped Rate pros:

• Peace of mind; you know your payments can’t go above a certain level

• You can benefit from the lower interest rates

Capped Rate cons:

• Despite your cap, interest rates could still go up, making monthly budgeting harder.

• Capped Rate mortgages are rare, so you may struggle to find one.

Specialist mortgages for bad credit

If you have bad credit, you might have been told you can’t get a mortgage. But that’s not always true! You may just need to apply for a bespoke mortgage with a specialist lender. If you’re struggling to remortgage or get on the property ladder, there are some specialist options you could explore. 

• Guarantor mortgages. A guarantor mortgage is where someone else agrees to pay for your mortgage if you can’t. They're a popular option for people with bad credit, low income, or a small deposit. 

• Joint Borrower Sole Proprietor mortgages (JBSP). A Joint Borrower Sole Proprietor mortgage (JBSP) is a mortgage that you take out with your parents or family member. You’re all responsible for paying the mortgage, but you’ll be the sole owner of the property. 

• Shared Ownership mortgages. A Shared Ownership mortgage helps people who can’t afford to pay the full market value of a home to purchase a share of a property and rent the rest. Shared Ownership is a good option for people who can't save up a big deposit. You'll generally put down a deposit of between 5-10% of the share you're buying.

• Right to Buy mortgages. If you're a council tenant in England, the Right to Buy scheme could offer a big discount on the price of buying your home. Once your landlord has agreed to sell your council home to you, the Right to Buy mortgage application process is basically the same as it would be if you were buying a house on the open market.