An Introduction to Mortgages
What is a Mortgage?
A mortgage is a long-term loan taken out to buy property or land. You repay the loan plus interest over a period of anything up to 35 years. A mortgage is the biggest, most expensive financial product most people ever take out, so it's important to understand the terms and pick the right mortgage for you. Also, since a mortgage is 'secured' against the property, if you don’t keep up with your mortgage repayments your lender can repossess your home. Get the wrong one and even if you don't lose your property you could end up paying tens of thousands of pounds more than you need to in interest and fees.
Different Types of Mortgage
With a fixed rate mortgage, your interest rate is set for a period of time, usually two, three, five or ten years. This means that your monthly payments will always be the same during that period, even if the Bank of England base rate goes up or down. These mortgages are best suited to people who are prepared to pay slightly more for the security of knowing exactly what they'll pay each month. Read our guide to fixed rate mortgagesto find out more.
With a variable rate mortgage, your interest rate can go up or down each month, depending on external factors. There are two main types:
These have an interest rate that 'tracks' either the Bank of England base rate or your lender's own standard interest rate. If you choose a mortgage that tracks the base rate, your interest rate, and the amount you repay each month, will change if the Bank of England changes the base rate. For example, a tracker mortgage might be 1% above base rate. If the base rate is 0.5%, you’ll pay 1.5%. So, if the base rate rises to 2%, you’ll pay 2.5%. If your mortgage tracks your lender's standard rate - known as the 'standard variable rate' or SVR - what you pay is based purely on your lender's whim. In general, SVRs go up and down in line with the base rate and the lender is allowed to change the rate whenever it sees fit.
This is a variable rate mortgage that tracks the lender's SVR, but several percentage points lower. For example, the discount might be 1% off the SVR. So if the lender’s SVR is 3%, you’ll pay 2%. A variable rate mortgage may suit you if you want to pay less now and are prepared to risk the chance of your monthly repayments rising if the interest rate you are tracking moves upwards. Read more in our dedicated guides to tracker and discount mortgages.
An offset mortgagelets you link your savings account, and sometimes your current account as well, to your mortgage so you only pay interest on the difference. For instance, if you have a mortgage of £100,000 and savings of £20,000 and £1,000 in your current account, you would only pay interest on £79,000 of your mortgage if you linked it to these accounts. Offset mortgages are ideal for anyone with a large amount of savings The good thing about offset mortgages is that while you benefit from lower interest charges (as you would if you paid off large chunks of your mortgage), you can also access your savings whenever you like, giving you the best of both worlds. Offset mortgages can be an ideal option for anyone with a large amount of savings, or self-employed workers who build up money to pay their tax bill each year. If that's you, then an offset mortgage will probably save you more money in unpaid interest on your mortgage than you could earn with a traditional savings account. Find out more with ourguide to offset mortgages.
Buy-to-Let (BTL) mortgages are specifically designed for landlords who want to buy a property to rent out to tenants. They are more expensive than ordinary residential mortgages because banks see rental property as higher risk, but if you are going to rent out a property using a mortgage you have to have a BTL mortgage. BTL mortgages are virtually identical to normal mortgages, for example you can choose between a variable or a fixed-rate interest rate. But, how much you can borrow will depend on the potential rental income of the property rather than your personal income. Also, BTL mortgages generally require a larger deposit than other types of mortgage. Check out our buy-to-let mortgage guide for more information.
Key Mortgage Phrases you Need to Know
If you've never owned a house before, you are a first-time buyer (FTB). Many lenders offer special deals for FTBs in order to help you onto the property ladder (and turn you into a long-term customer). So be on the look out for mortgages designed specifically for FTBs.
This is when you take out a new mortgage to pay off an existing one. The most common reason to do this is to save money. For example, you might be on a two-year fixed rate and find your payments go up (normally to the lender’s SVR) after the fixed period ends. At this point you may want to consider remortgaging to get a cheaper rate. Some people also remortgage in order to borrow a larger amount so they can pay off their debts or pay for home improvements.
This means moving your mortgage from one property to another allowing you to move home without remortgaging. Not all mortgages allow porting, so if it is something you think you may need check the terms and conditions before you take out a mortgage.
You'll see this thrown around a lot when you are looking for a mortgage. It means the amount of money the bank is lending you as a percentage of the value of your home. So, if your home is worth £200,000 and you've got a £40,000 deposit, you need to borrow £160,000 or 80% of the value of your home. This means you're LTV is 80%.
Mortgage Fees - How Paying them can SAVE you Money
Whatever type of mortgage you choose, you’re likely to be hit with a large arrangement fee of around £1,000 or more. This can be paid upfront, or added onto your mortgage, which means you will pay interest on it for up to 35 years. You may also have to pay legal, booking and valuation fees. You might save money by paying a fee in return for a lower interest rate But some lenders offer fee-free mortgages, which can sound very enticing. After all, you're saving around a thousand pounds by not paying the arrangement fee...aren't you? In fact, fee-free mortgages tend to have higher interest rates. So, you might actually save money by paying a fee in return for a lower interest rate. Whether a fee-free mortgage will work out cheaper for you depends on the size of your loan and the size of the fees you might otherwise pay. You can work out the comparative cost of a fee-free mortgage vs a lower interest rate with this calculator and you should also read our guide on fee-free mortgages.
Where to get a Mortgage
Banks, building societies and specialised mortgage lenders all sell mortgages. But don't just wander into your local bank and start filling out application forms. To get the best deal you should use a comparison website. Our mortgage tool searches over 5,000 mortgages in seconds. Give it a try now to find out what your mortgage options are.
What you need to get a Mortgage
You need to save a deposit to get a mortgage, and the bigger the better. If you save a 10% deposit, your mortgage will be 90% of the property’s value. This is known as the loan-to-value (LTV). In general the lower the LTV, the better the interest rate you’ll be eligible for.
A Good Credit History
A lender will check your credit history when you apply for a mortgage. They will want to see how you’ve handled borrowing money in the past and if you pay bills on time. The better your credit history the lower the interest rate you will be offered on your mortgage. Read our guides to understanding your credit scoreandimproving your credit ratingto find out more.
Proof of Affordability
Mortgage lenders will check if you can afford your mortgage. To do this they look at your income and outgoings. If you’re employed they will want to see your payslips, and if you’re self-employed they'll want to see your accounts for several years. Then they will look at your other financial commitments and decide how much they will lend to you.
A Potential Home
Your mortgage lender may well give you a 'mortgage in principle' before you have chosen your dream home. But they won't release the funds until they've carried out a valuation of the property you want to buy. This is so they can make sure it is worth what you intend to pay for it, so they can be sure they'd get their money back if they had to end up repossessing your home.
Repaying your Mortgage
When you take out a mortgage you’ll agree a 'term' with the mortgage lender. This is how many years it will take to pay it back. 25 years is the standard mortgage term but most lenders allow terms of up to 35 years. If you can pay the loan off quicker, you can agree a shorter term. Your mortgage lender will tell you the monthly payments you need to make to repay the mortgage by the end of the term, but you can get an idea of what you'll pay with this calculator. Mortgage repayments have two parts:
Capital - This is the money you borrowed.
Interest - This is your payment to the lender.
There are two ways you can repay a mortgage:
Repayment - This means you pay off some of the capital and some of the interest each month. So that, at the end of the term, you’ll own your property outright.
**Interest-only **- This means you just pay off the interest each month so your repayments will be smaller. But, the big drawback here is that at the end of the term you’ll still owe the capital you borrowed. For this reason mortgage lenders will insist you have a plan in place – such as an investment – to repay the capital.Interest-only is also more expensive in the long-run as you are paying interest on the full loan for the entire length of the mortgage. In contrast, with a repayment mortgage the amount of interest you are paying slowly falls as you repay the capital.
If you fall behind on your monthly mortgage payments, this is known as “arrears”. If you don’t pay off your arrears when requested by your mortgage lender, it may eventually repossess your home.