What is a mortgage?
What is a mortgage?
For most people, buying a new home means getting a mortgage.
But what exactly is a mortgage?
A mortgage is a loan taken out to buy property and/or land.
The average length of a mortgage is 25 years but the ‘term’ (the length of the loan) can be shorter or longer depending on your financial preference and circumstances.
If you are buying a house with a mortgage you will need to pay a deposit (in other words, you will need to find part of the cost from you own savings) and a lender (such as a bank or building society) will lend you the rest.
The value of your home is used as security for the loan until it has been paid off in full.
This means that if for any reason you are unable to keep up the repayments, the lender can ‘repossess’ the property (take ownership of it – which means you will have to move out). The lender can then sell the house to someone else to get back the money that it has lent to you.
Where can I get a mortgage?
Your bank or building society will have a range of products that you can choose from and you can also use a mortgage broker or independent financial adviser (IFA) who can compare different mortgages on the market. If you are buying a new-built house from a builder it will often be able to introduce you to an IFA who can advise you. The IFA will work for you, not for the builder, and will provide advice tailored specifically to your needs.
If you are buying a new home from Larkfleet we can introduce you to an IFA who will look after your interests and give you sound advice.
The best thing to do with a commitment this size is to seek advice - and plenty of it - so that you know you are doing the right thing and at the right time. You need to get the right mortgage for your individual circumstances. The wrong choice can end up costing you thousands of pounds over the term of the mortgage. The mortgage with the lowest interest rate is not always the cheapest deal when all other costs and fees have been taken into account.
We recommend Evolve Financial Solutions as an independent financial advisor.
You can get information about other independent financial advisors and guidance on how to find one that meets your needs here.
How much can I borrow?
The amount you can borrow depends on your income, your age (many lenders are reluctant to lend if the term means you will still be paying off the mortgage once you retire) and ‘credit scoring’ (whether you are seen as someone who can afford to pay the mortgage). You can check your credit score with a reference agency such as Experian.
It is recommended by money-saving experts that you should check your credit score before starting the process of applying for a mortgage. Be sure, for example, that your address and contact details are up to date on the credit score report and that there are no mistakes on the record about any debts you have. Lenders may be suspicious if your application for a mortgage does not mirror what the credit score report says.
If you do find mistakes in your credit score report, you can get them put right. There is advice here on how to do that.
As well as the mortgage payments and your income, other factors which you (and mortgage lenders) will want to consider in deciding how much you can borrow will be things such as household bills, Council Tax, insurance and maintenance.
For a rough idea of how much you can afford to borrow you can use our mortgage calculator.
The last thing you want to do is overstretch yourself when it comes to repayments. This is a long-term commitment and, as the mortgage adverts consistently remind us, your home is at risk if you do not keep up your payments.
Alongside your existing financial commitments, lenders will want to see that you can keep up repayments if interest rates rise.
Finding your deposit
It is no secret that house prices have risen over recent years and raising a deposit for a property is often the biggest challenge facing new home owners.
Different lenders will have different ‘rules’ about how much deposit you must provide. Your IFA, if you use one, will be able to advise you on where to get the best deal.
Raising just a 5 per cent deposit to buy a £150,000 home means you will need £7,500. To get to 10 per cent you will need £15,000 and to reach the average first-time buyer deposit of 20 per cent you will need £30,000.
Taking this into account, the government has launched various schemes to help first-time buyers get onto the housing ladders. A great example of a scheme that is really working is the Help to Buy scheme.
The Help to Buy scheme allows homebuyers to own 100 per cent of a new home with just a 75 per cent mortgage and a 5 per cent deposit. The remaining 20 per cent of the purchase price is paid for with a loan from the government (subject to approval).
The loan is interest-free for five years and can be repaid at any time or on the sale of the home.
Different types of mortgage
There is a bewildering choice of different types of mortgage. We’ve given brief details of some of them below but (as we’ve said before) the best advice is – get some advice!
Repayment mortgage This is the most usual form of mortgage.Each month you repay some of the interest you owe plus some of the original amount of money you've borrowed. At the end of the ‘term’ you will have paid back everything you owe.
Interest only mortgage With an interest-only mortgage you just pay the interest owed each month and then repay the original sum that you borrowed right at the end of the term. Of course, that does mean you need to find that large amount of money all at once – but maybe in 25 years it won’t look so big! Meanwhile though, the advantage is that your monthly repayments are lower than with any other mortgage because you are paying only the interest.
Fixed rate mortgage As the name suggests, with this type of mortgage your interest rate is fixed so that you know exactly how much your repayments will be. Different lenders offer different options – you may be able to fix your rate for two, three, five or even ten years. Generally, the longer the time for which you fix the payments, the more those payments will be.
Variable rate (SVR) mortgage Most banks and building societies offer a standard variable rate (SVR) mortgage. The interest rate (and therefor your payment) goes up and down – generally in line with the Bank of England base rate but there may be other factors taken into account as well. And a fall in the Bank of England rate does not always mean a fall in your mortgage payments. You take the risk that interest rates may go up substantially.
Tracker mortgage Tracker mortgages move in line with some external indicator which they ‘track’. Usually this is the Bank of England base rate. That is not actually the rate you pay – your payments will be set at a fixed amount more than the ‘tracked’ index. But when the index goes down, your payments also go down. Of course, when the index goes up, so do your payments!
Discount rate mortgage The ‘discount’ in the name is a reduction from the lender's standard variable rate (SVR). As with SVR mortgages, the rate will go up and down when the SVR changes. And the discount applies for only a limited period – maybe the first two or three years of your mortgage.
Capped rate mortgage This is another variation on the SVR mortgage but one with a limit (a cap) on how high your interest rate can rise. It does provide you with some comfort in knowing that your repayments will never exceed a certain level while you still benefit when rates go down.
Cashback mortgage When you take out a cashback mortgage, you get some of the loan back as a lump sum right at the start. This can be helpful if you need to cover things like legal fees, decorating or moving costs from your mortgage. It does, of course, come at a cost – you will generally get better deals without cashback.
Offset mortgage Offset mortgages combine savings and mortgage together. Each month, the lender looks at how much you owe on the mortgage and then deducts the amount you have in your savings account with the lender. You pay mortgage interest just on the difference between the two. This cuts the amount of interest you pay but the mortgage rate is likely to be more expensive than on other deals – and, of course, you don’t earn any interest on your savings.
Flexible mortgage If you have a variable income (for example, if you are self-employed) a flexible mortgage can be helpful. You can put in more than the minimum payment each month and then, if you hit a period where your income goes down, you can skip a payment or two if you have previously overpaid. In return for this flexibility, however, you will pay a higher rate of interest than on other types of mortgage.
What documents will I need?
You will need to show proof of your income to lenders. This could include bank statements and wage slips. Lenders will also want to see proof of other expenditures and debts and might ask for information about household bills, child maintenance and personal expenses.
Can I remortgage?
You do not have to stay in a contract (mortgage) that no longer suits you.
Many people find that their financial circumstances change and they therefore opt to ‘remortgage’ their property – ie, ‘pay off’ the existing loan and take out a new one. The new loan may be used to pay what you still owe on the previous mortgage. If you borrow more on the new mortgage than is owed on the one that you are paying off you can use the difference to pay for home improvements or other things.
The process is similar to obtaining your original mortgage although much of the legal work will have already been done. However, you will need to still pay mortgage fees and there may be costs to pay to your existing lender for ending the loan early.
Keeping up the payments
As much as we would like life to follow the perfect consistent pattern, sometimes things will come up that we might not expect or have not prepared for. This can apply to your financial situation too. However, if it comes to a point when you feel you are struggling to make repayments on your mortgage, you MUST act before the situation becomes unrepairable.
The first thing to do is contact your mortgage lender. It is their duty to work with you and make reasonable attempts to resolve the problem. This can be done by looking at when and how much you are paying each month. Don’t panic. They cannot repossess your property until all attempts have been made to solve the situation.
The next best thing to do is check your insurance cover. Do you have mortgage protection cover? This should cover part/all of the payments if you have had misfortune through an accident, redundancy or sickness.
You will find plenty of advice online about what to do if you are faced with this difficult situation.
We would recommend starting your search here with the Money Advice Service.