The Complete Guide to Mortgages
Buying your first home is an exciting time, but it can also be overwhelming. Once you’ve found your ideal property, there’s so much to organise. Estate agents, surveyors and, of course, sorting out your mortgage.
If you’re feeling stressed about it all, don’t worry. We’ve answered all your questions about mortgages, so you know exactly what to expect when you’re ready to purchase your dream home.
What is a Mortgage?
A mortgage is a special type of loan specifically taken out to purchase property or land. Typically, repayments are spread over 25 years, but you can have longer or shorter terms if you prefer.
A mortgage is secured against the value of your home until the final payment is made.This means that if you cannot afford to make repayments, the lender can repossess (take ownership) of your property and sell it to pay off your debt.
Where Can You Get a Mortgage?
You might find it easiest to go directly to your bank or building society and choose a mortgage from their product range.
This has the advantage of the lender knowing your financial history and being able to help you work out how much you can afford to borrow.
The disadvantage is that they may not have the most competitive rates available and if you only speak to your bank or building society, you may commit yourself to paying more than you need.
Or you could go to a mortgage broker or independent financial adviser (IFA) who will be able to compare all the available mortgages for you.
They will also be able to look at mortgages that are not directly available to borrowers to source the best possible deal.
A good starting point to research mortgages is to go to a comparison site, such as MoneyFacts or MoneySuperMarket.
These sites can give you an idea of the types of mortgage available and what kind of repayment you might be expected to make.
What Are the Different Types of Mortgages?
Whatever type of mortgage you take out, you will be charged interest on the outstanding loan until you have paid it off, just as you do with most types of loan.
Interest is the extra amount that you pay on top of the initial loan amount and is calculated as a percentage of your loan. The amount of interest you will have to pay will vary according to the terms of your mortgage.
1. Repayment or Interest only?
This is a choice you will need to make when you take out your new mortgage, and it depends on your situation and your lender which type you are eligible for. So what’s the difference?
Repayment mortgages
Repayment mortgages are where you pay back some of the loan PLUS the interest every month. The monthly repayments will therefore be higher as you are paying the original amount as well as the interest.
However, on a repayment mortgage you will pay the whole loan back over the term.
Interest-only mortgages
Interest-only mortgages are where you only pay the interest without repaying the loan, making your monthly repayments lower.
If you do take out an interest-only mortgage, you will need to have a plan for how you will repay the outstanding capital at the end of the term.
After you have decided on your payment plan you need to decide with your lender on the best mortgage for you. There are two basic types of mortgage: fixed and variable:
2. Fixed Rate Mortgages
As the name would suggest, fixed rate mortgages have fixed repayment amounts based on an agreed interest rate for a certain period, usually between 1-5 years, although it is possible to fix interest rates for up to ten years.
This means that you know exactly how much you will be expected to pay, no matter what happens to interest rates, which makes it easy to budget.
The downside is that if interest rates fall, you could be paying more than you need and there’s a penalty if you want to get out of the mortgage before the agreed fixed rate period ends.
Think carefully about how long you want to be tied to your mortgage if you don’t want to pay a fee of possibly thousands of pounds.
3. Tracker Mortgages
A tracker mortgage uses the Bank of England’s base interest rate to calculate the interest on your mortgage.
This means that the amount of interest you pay, and therefore your repayment amount, will vary according to changes in the base rate.
For Example:
If the base rate is 1% and you opt for a tracker mortgage with an interest rate 2% higher than base rate, you will be paying 3% interest on the outstanding amount.
If the base rate increased by 0.5% to 1.5%, your interest will change to 3.5%. You can arrange a tracker rate over a fixed term, usually 2-5 years, just like fixed rate mortgages.
If you decide to get out of the mortgage before the term ends, for example you want to sell your house or switch mortgages, you will be charged a penalty.
However, lifetime tracker mortgages, otherwise known as term tracker mortgages, are available, frequently without penalties, making them a very flexible alternative.
Tracker mortgages tend to have lower interest rates than fixed rate loans, so they may be cheaper and although rates can vary, this happens only when the Bank of England changes the base rate.
But, you need to budget how much you will have to repay should rates go up and if you think you will struggle, a fixed rate mortgage might be better suited to your needs.
4. Discount Mortgages
Discount mortgages are an alternative to tracker mortgages.
Interest rates on these loans are also variable, but in this instance, the rate is linked to the lender’s standard variable rate (SVR) instead of the Bank of England’s base rate.
You should be aware that lenders can change their SVR at any time, even if the base rate stays the same.
Again, discount mortgages are available for an agreed term of usually 1-5 years and usually come with a penalty should you decide to change your mortgage or repay the loan early.
5. Offset Mortgages
Another option available is offset mortgages. An offset mortgage is linked to your savings account, so that instead of earning interest on your savings, you can reduce the amount of interest you have to pay on your mortgage.
This can make it easier to pay off your mortgage sooner or make your monthly repayments lower.
If you have an offset mortgage, you can still make withdrawals from your savings account, but you should be aware that this will impact on how much you save on your mortgage repayments or reduce the term of your mortgage.
However, you can also make more deposits, which will save you even more on your mortgage.
Offset mortgages are available with either fixed or variable rates and you may find that you save more by offsetting your mortgage than you would have gained in interest on your savings.
You can choose to repay the loan partially in full at any point, but you may face a penalty if you do this during an agreed fixed or variable rate period.
Applying for a Mortgage
There are two basic steps to getting a mortgage:
Step 1:
The first step is to speak to your financial adviser or bank/building society to work out how much you can afford to repay and which type of mortgage is best for you.
Step 2:
The second step involves the lender carrying out a background check to ensure you can afford the agreed repayments.
They will also calculate whether you can afford repayments in the event of an increase in interest. They may require you to provide evidence of income as part of this process.
When your application has been accepted, you will be given a ‘binding offer’ as well as detailed documents explaining the terms of your loan agreement.
You will also have a ‘reflection period’ of 7 days, sometimes more, so that you can compare your agreed mortgage with other available loans and make sure that you’re happy to go ahead.
However, if you need to close the deal quickly, you can opt to waive the reflection period.
Paying a Deposit
Although it used to be possible to take out 100% mortgages (or even higher), lenders are more cautious these days and expect you to be able to put down a sizeable deposit (calculated as a percentage of the purchase price) towards the cost of your home.
The larger the deposit, the better.
While you may be able to get a mortgage with only a 5% deposit, many lenders ask for 20%, so you need to think about this when calculating how much you can spend on a property.
Lenders sometimes use the term “loan to value” (LTV) when talking about mortgages. This is the amount of the property you own outright compared to the outstanding mortgage.
For Example
If you pay a £20,000 deposit towards a £100,000 property, you own 20% of your home with the LTV standing at 80%. It is this 80% that the mortgage is secured against.
The lower the LTV, the easier it is to negotiate a lower interest rate.
This is because the smaller the loan, the less risk there is for the lender. If you are able to put down a 40% deposit, you are usually able to get a very low rate of interest.
What is a Guarantor Mortgage?
If you cannot afford a large deposit on a home, don’t despair. There are a few options available that could still see you take your first step onto the property ladder.
One of these is to take out a guarantor mortgage. A Guarantor mortgage enables you to take out a larger loan than you might otherwise be able to if a close relative is willing to act as guarantor on your mortgage.
In these circumstances, your parents or grandparents put up their own property as collateral against your mortgage.
You will need to have a sizeable amount of equity in their property – usually 25% is the minimum – and the lender will put a charge on this. As long as you keep up your repayments, your parents or grandparents will not need to pay a penny.
However, everyone involved should think carefully before taking on this type of mortgage. Why?
If you default on your loan, your guarantors will be liable and may have to remortgage their homes to cover the debt. In worst case scenarios, they may even have their properties repossessed.
What is a Parents And Family Offset Mortgage?
An alternative to a guarantor mortgage is a family offset mortgage. This is similar to an offset mortgage, but in this instance, the relative puts their savings into an account linked to your mortgage.
You will not have access to this money, but it serves as a deposit on your property and lowers the interest you will have to pay, since the savings balance is offset against the outstanding loan.
This type of mortgage has the advantage that your parents or grandparents don’t have to risk their home, nor do they have to give away any money, although they will not have any access to it for a while, usually until your mortgage is reduced to 75-80% of the property value.
However, once you’ve paid off the agreed amount of your mortgage, they will be able to get their money back.
Some family offset mortgages allow your parents or grandparents to accrue interest on their savings while they are offsetting your mortgage, leaving you to come up with a deposit of just 5%.
It is worth comparing the interest rates on these special types of mortgages to see if it is a viable, economic alternative for you.
With so many types of mortgages available on the market, you’re bound to find one that suits your needs. Once you’ve agreed your mortgage, owning your home is not far behind!
Are you a first-time buyer? What type of mortgage do you think you’ll take out? Let us know your experiences in the comments below.
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Thank you for sharing this useful guide. It has given me a good overview of mortgages.