What is a mortgage and is it right for me?
If you are looking to buy a property, then unless you happen to be a cash buyer you will most likely need to get a mortgage. Taking out a mortgage can be one of the biggest financial decisions you make in your lifetime, so it makes sense to find out what types there are and how they work before deciding what sort of mortgage suits your circumstances. We’re here to break down everything you need to know about mortgages, interest rates, deposits and more.
What is a mortgage?
A mortgage is a loan taken out to buy property or land. It is a type of secured loan, where the property itself acts as the security. With a mortgage, a bank or building society will lend you money to buy a home, and you agree to make regular payments to pay back the money you have borrowed, plus interest.
As the mortgage is secured against your property, if you fail to keep up with your repayments the lender could repossess your home.
What are the types of mortgages?
There are thousands of mortgage deals available, some aimed at first-time buyers and some aimed at remortgagers. Mortgages are offered by dozens of lenders, so it’s important to take the time to find the right one for you. To start you off, here are the most common types of mortgages:</.p>
Fixed rate mortgages
With a fixed rate mortgage, the interest rate you will pay will stay the same throughout the length of the deal. So if you take out a two-year fixed rate mortgage at 1.20%, that interest rate will stay the same throughout the two-year period.
The benefit of a fixed rate mortgage is that you know what your monthly repayments will be during the deal. However, if the Bank of England base rate were to fall, you wouldn’t experience any benefit. And interest rates for fixed rate mortgage tend to be slightly higher than for variable rate mortgages.
Standard variable rate mortgages
A standard variable rate (SVR) mortgage is one at the normal interest rate your lender charges borrowers. The SVR is also the rate that mortgages that have come to the end of their deal often revert to.
The advantage of this type of loan is that you can overpay or leave at any time. You are not tied into a specific deal. However, your rate can be changed at any time. It may go down, but it may also go up, which would make your mortgage repayments higher.
A discount mortgage is a discount off the lender’s SVR for a certain period of time. For example, you might take out a two-year discount mortgage that has a 1.5% discount off an SVR of 4%. So for two years, the interest rate you would be required to pay on your mortgage would be 2.5%.
The bonus to this is that if the lender were to reduce its SVR, you would also benefit from the cut, while already paying a lower rate. On the flip side, though, if the lender increases its SVR, your rate will also increase. Also, with this type of mortgage, you need to watch out for charges for leaving before the end of the discount period.
A tracker mortgage typically tracks the Bank of England base rate: it is the base rate plus a few per cent. The base rate currently stands at 0.75%, so if you were to take out a tracker mortgage you would be paying 0.75% plus whatever interest rate your lender applies to the loan.
This means that if the base rate goes down, then your rate goes down. But if the Bank of England increases the base rate by 0.5%, your rate will also increase by 0.5%.
Capped rate mortgages
With this type of mortgage, your rate won’t rise above a certain level (cap). Basically, you place a cap; then, if your lender were to raise its SVR, your rate wouldn’t rise above the cap.
Caps tend to be quite high, so try to make sure you could afford the repayments if the SVR rises to the level of the cap.
The main advantage of this type of mortgage is that your rate becomes lower if the SVR falls, but you are protected if it goes significantly higher.
An offset mortgage allows you to use savings in a linked account to subtract from the amount of mortgage you are required to pay interest on. So, for example, if you have a mortgage of £300,000 and £20,000 in the linked savings account, you will only be required to pay interest on £280,000.
How do mortgages work?
Mortgages work by you (the borrower) placing a deposit, and the lender then lending you the remainder of the value of your property with an interest rate attached to the loan. We’ll cover more about deposits later, but typically you will need a deposit of at least 5% of the property value.
Once you have your mortgage in place, you will be required to make monthly repayments, which will include your interest charges – either at a fixed or variable rate, depending on what type of mortgage you have chosen.
What does the mortgage process look like?
If you are a first-time buyer, the mortgage process is relatively straightforward; but if you are looking to move or sell your house, things are a little bit more complicated. Let’s break it down:
The main issue for first-time buyers is whether they will be approved for a mortgage. The first thing to do is to save a deposit, as you will need to provide a deposit if you are buying your first home.
Secondly, either compare mortgage products or use a mortgage broker in order to find a mortgage that suits you and that you will be able to afford. Remember to not only look at the interest rate and level of deposit required, but also at any arrangement fees attached and, if you have chosen a variable rate mortgage, whether you can afford the repayments if the interest rate increases.
The next step is to get yourself a ‘mortgage in principle’. Also known as a ‘decision in principle’, this is a statement from the bank or building society saying that, in principle, it is willing to lend you a certain amount of money subject to you passing full affordability checks. Estate agents might ask whether you have a decision in principle if you are starting to view properties.
Once you have found the property you want to buy, you can then begin your mortgage application. As part of this, the lender or mortgage broker will begin a full fact-find and conduct a full affordability assessment. As part of this, you will need to provide evidence of your income and specific expenditure. If your application is successful, the lender will provide you with a ‘binding offer’.
Moving or selling your house
If you are moving or are selling your property, then many mortgages will allow you to ‘port’ them to a new property, essentially moving the mortgage from one property to another. However, by doing this, you effectively have to reapply for your mortgage, so you will need to prove to the lender that you can still afford your monthly repayments.
If you are looking to borrow more money to move to a new home, you can apply to your lender for additional funds. But be warned, any extra borrowing may be charged at a different rate.
If you aren’t tied into your current mortgage deal and there aren’t any early repayment charges, then you can just remortgage with another lender.
If you have come to the end of your current mortgage deal, you may want to consider remortgaging with another lender in order to secure yourself a lower interest rate.
If you do remortgage, you will need to find out how much equity you now own in your property. You will need to get a valuation of your home and then see how much of your mortgage balance you have left to pay. Your valuation minus the outstanding balance is the amount of equity you have in your property. This then acts as your deposit for your new mortgage.
The remortgaging process is pretty similar to that when taking out a mortgage for the first time. You will need to apply for your chosen mortgage product and undergo the affordability checks. The process typically takes from 4 to 8 weeks after you apply. You may also find that you need a solicitor or conveyancer to handle the transfer of your mortgage, but some lenders offer this service for free.
What is a mortgage broker?
A mortgage broker is a professional advisor who can find and apply for a mortgage on your behalf. Trying to search for the right mortgage and complete all the necessary steps can be quite confusing, but a mortgage broker can help you through the process.
If you choose to use a mortgage broker, it will work directly with you to help you decide what kind of mortgage you need and then find deals that match your criteria. The broker will then arrange the mortgage between you and the mortgage lender.
The advantage of using mortgage brokers is that they have the knowledge and expertise to find you the best deals. And due to their experience and contacts, they typically have access to a wide range of lenders.
However, there are some downsides to be aware of. Not all mortgage brokers are free, so definitely compare fees before deciding which broker to go with. Also, not all brokers have access to the entire mortgage market. They may only have a set number of lenders they work with, so try to ask how many and whether they have a preference before committing to a broker.
What is a mortgage deposit?
A mortgage deposit is a sum of money you are required to provide in order to secure your mortgage. Your deposit will determine the loan-to-value (LTV) ratio on your mortgage; this is the maximum amount your mortgage provider will lend you as a percentage of the value of the property.
You will most likely need to have a minimum deposit of at least 5%, but more often than not you will find it is 10%. With a deposit of 10%, you are looking at mortgage with a 90% LTV. The lower the LTV, the more likely you are to achieve a good interest rate.
To break it down further, if you were looking to purchase a property worth £200,000 and you had found a mortgage product with an 80% LTV, the most you would be able to borrow would be £160,000. You would need to provide a deposit of £40,000.
If you are a first-time buyer, you will need to provide the deposit as cash; but if you are remortgaging, you can use the equity you have in your property as your mortgage deposit.
How long do I have to pay off my mortgage?
A typical loan period for a mortgage is 25 years. So this means that you have 25 years in which to repay the loan in full.
However, as mortgages have become more expensive over time, people are borrowing for longer in order to give themselves time to clear the debt; some mortgages now run for 30 or 35 years. You can also have a shorter period of time, which may be useful if you are nearing retirement. You can work out what period you can afford by using an online mortgage calculator.
Is a mortgage right for me?
Whether or not a mortgage is right for you depends on your personal circumstances. If you are looking to buy a property but are not able to afford the full amount in cash, then a mortgage can help you achieve what you want.
However, a mortgage is a big financial commitment. In order to be approved for a mortgage, you will need to have a good credit score to show that you can borrow responsibly. Lenders will also undertake an affordability test to make sure you are not stretching your finances too much, and that you would still be able to afford to make repayments even if interest rates were to rise.
A mortgage can make the difference between being able to own a property or not. But if you are unable to keep up with the repayments, it could lead to your home being repossessed by your lender. In order to get the best deal for you, try to shop around and compare products where you can.