A Beginner’s Guide to Mortgages
Mortgages can be confusing. If you’re buying a house for the first time, you’ll want to understand exactly how much you’re able to borrow, what you need to apply for a mortgage, and what your options are for types of mortgages.
Our guide to mortgages cuts the jargon and simply explains the process, so you’ll know exactly how mortgages work, how to apply for a mortgage and how to make the repayments.
What is a Mortgage?
A mortgage is a loan that’s specifically used to buy property or land. The average time you’ll have to pay off a mortgage is 25 years, but the length of time can sometimes vary depending on the terms of the mortgage.
Your property is used as security during the loan period. This means that if you aren’t able to keep up with repaying the loan, the lender can take back the property (known as “repossession”). They’ll then sell it on so they can get their money back from what they loaned you.
Can I Afford a Mortgage?
You shouldn’t overextend yourself with the cost of mortgage repayments. The amount you’ll need to pay back each month can rise or fall, depending on your mortgage terms and interest rates. So, you shouldn’t calculate how much you’ll be able to repay based on the lowest possible amount.
You’ll also need to consider how much it takes to run a house, like utility bills, council tax and general maintenance. You’ll need to be able to afford all these outgoings along with the mortgage repayments. The government has a Mortgage Affordability calculator which can help you work out how much you’ll be able to pay back every month.
Most lenders will offer a mortgage up to 4.5 times your annual salary, or 4.5 times the annual salary of you and a partner combined if you’re buying with someone else. Your salary and your employment status (whether you’re employed or self-employed) will contribute to whether a lender will be able to offer a mortgage.
When you apply for a mortgage, the lender will want to see proof of your income, the outgoings you pay and whether you have any debt. They’ll also check your credit score and financial history. They will want to ensure that you’ll be able to make the repayments on the mortgage even if the interest rates rise.
If you’re unable to provide the necessary proof, or if there is anything in your finances that suggests you may not be able to make the repayments, a lender may refuse to give you a mortgage.
How Do I Get a Mortgage?
Banks and building societies offer mortgages and usually have a range that you can choose from. You can go to these organisations directly to apply for a mortgage.
Alternatively, you can go to a mortgage broker or an independent financial advisor who can help you to compare mortgages and find the right option for you. You will usually have to pay a fee to use their services, but it can be helpful to take advice if you’re new to understanding mortgages. You could end up saving money in the long run as they will help you to get the best deal.
How Much Do I Need for a Deposit?
The deposit is an amount of money that you’ll pay towards the cost of the property you’re buying. Everyone who buys a property will need to pay a deposit.
The amount of the deposit is usually at least 10% of the total value of the property. So, if you’re buying a home for £200,000, you’ll need to pay a deposit of £20,000.
You can pay a deposit higher than 10% if you’d prefer. The higher deposit you pay, the better interest rates you could have on your mortgage.
If you’ve paid a £20,000 deposit of your £200,000 home, you now own 10% of that property. The mortgage will be secured against the remaining 90% of the property that you don’t yet own. This is called the “Loan to Value” or LTV.
The lower the LTV, the better the interest rates are likely to be. This is because the loan you receive will be smaller, so the lenders are taking less risk.
How Do I Prepare for a Mortgage Application?
Set Your Budget
Before you apply for a mortgage, you’ll want to make sure your finances are in order. You should prepare a budget so you can understand exactly how much you’ll be able to afford to pay on a mortgage each month, in addition to all your other outgoings.
Check Your Credit Report
You should also check your credit report, as this will bring up any problems that may prevent a lender from giving you a mortgage. Money Saving Expert has a guide to check your credit score for free as some sites may try to charge you a one-off fee or monthly subscription.
You should check all the information is correct and you have nothing outstanding that you need to take action with. You should also make sure that you’re not linked with another person who you are no longer associated with, such as an ex-partner or family member. If they have bad credit, this can affect your score. Some things, like bankruptcies or missed payments on a loan, can take six years to clear from your credit report. Most lenders won’t offer mortgages to people with these types of records on their credit report, so you may have to wait for them to clear before you apply for a mortgage.
Prepare Your Paperwork
A lender will usually need to see the following paperwork so they can assess and approve your mortgage:
- Proof of name and address (this usually includes your passport or driving licence).
- Proof of income. This will be payslips for the last three months if you’re employed. If you’re self-employed, you’ll need your SA302 tax return and bank statements.
- P60 from your employer
- If you have income from more than one source, you’ll need the SA302 tax return form.
- Bank statements from your current account from the last three to six months.
- Utility bills.
- Proof of benefits received (if relevant).
- Proof of deposit for the property.
You should make sure all the information is accurate and matches what you put on your mortgage application exactly.
Some lenders might have different requirements and need extra paperwork. Print outs of statements aren’t always accepted. You’ll either need original hard copies, or you’ll need to have print outs certified by a solicitor, or the bank or utility provider.
How Does the Mortgage Application Process Work?
The lender or mortgage broker will begin by speaking to you to determine what kind of mortgage you want and how long you want it for. They’ll ask for a brief outline of your financial situation. This is so they can get an idea of how much a lender could offer you. They’ll also give you information about the mortgage product, their services and any fees that you could pay.
Once all the information has been collected, the formal application can begin.
The lender will begin collecting detailed information about your situation so they can thoroughly assess what you can afford. This is where you’ll need to provide evidence of your finances. They will also conduct a “stress test” which is where they evaluate whether you would still be able to make repayments if interest rates were to rise. To do this the lender will ask questions about your future plans that might impact your income.
If your application is accepted, you’ll receive a “binding offer” from the lender. You’ll get a mortgage illustration document which explains the terms of your mortgage in detail.
You’ll then be entitled to a “reflection period” where you can make your own assessment of the mortgage and the terms. You could use this time to make comparisons to other mortgages and make your own evaluation of what accepting the terms will mean for you. This period usually lasts for seven days, although some lenders may give you longer.
If you don’t need that long, you can request to skip the reflection period or shorten it. You may wish to do this if you know you’re happy with the terms and you want to complete your property purchase quicker.
What are the Types of Mortgages?
Lenders will charge you interest on the amount you have borrowed until you have paid it back. With most mortgages, you will pay back a portion of the interest and the original loan amount (known as the “capital”) every month. After the loan term, you will have completely paid off both the original loan and the interest. You will then fully own your home.
There are a number of different types of mortgages on offer, which will have different implications and affect how much interest you have to pay.
Fixed Rate Mortgages
With a fixed rate mortgage, the interest rates will be fixed for a specific period of time – typically between two and five years. This means that your repayments will stay the same throughout this period. It is usually an introductory offer and will have lower rates than other types of mortgages.
You can sometimes get a fixed rate mortgage for a ten-year period; however, these are becoming less common. When the period is this long, you are more at risk of missing out of lower interest rates by being locked into a fixed rate.
Once the fixed rate term is up, most mortgages will become either a standard variable rate mortgage or a tracker mortgage.
The interest rate charged on tracker mortgages follows the Bank of England base rate. There may also be a margin above the rate. For example, if your tracker mortgage was the base rate plus a 1.5% margin, your interest rate would currently be 1.6% – 1.5% plus the 0.1% from the Bank of England.
The advantage of tracker mortgages is that if the base rate drops, you will instantly see this reflected on your mortgage. On the other hand, if the base rate increases, your repayments will also instantly increase.
Standard Variable Rate Mortgages
With a standard variable rate mortgage, the rates can increase or decrease the same as the tracker, but the rate will be determined by the lender. Sometimes they choose to follow the Bank of England rate, but not always.
Standard variable rate mortgages can offer a better deal than trackers, as the lender will usually want to provide an attractive long-term deal for their customers and themselves. So, if the Bank of England rate is particularly high, they may not follow it, which will mean you’ll pay less than on a tracker. However, if the Bank of England rate is particularly low, the lender can choose not to follow it and you could miss out on the low interest rates.
Are there Other Types of Mortgages?
There are other types of mortgages available, that are less common than the above.
Interest only Mortgages
Interest only mortgages are higher risk than the other types of mortgages. Throughout the mortgage term, you would only pay off the interest, not the original loan amount. So, when the term finishes, you’ll still need to pay back the original amount.
As well as providing proof that you’ll be able to repay the interest payments, you’ll also need to have a plan to repay the original loan. Usually, people who have investments that they can cash out at the end of the term qualify for interest only mortgages. These types of mortgages are highly regulated and very few people meet the criteria.
It was recently announced that 95% mortgages would become available for a period of time – currently between April 2021 and December 2022, with the possibility of an extension. This would mean that a buyer will only need to pay a deposit of 5%, rather than the usual minimum of 10%. So, if you’re buying a property for £200,000, you only need a £10,000 deposit.
There are some restrictions to this scheme. The property will have to be your main residence, not a second home or one you will be renting out. Also, just because the deposit is lower, you might not save money in the long run. You may end up spending more on repayments as the best interest rates are generally given to people who can pay bigger deposits.
This type of mortgage will be linked to any savings you have and will “offset” them against the mortgage. This can get better deals for people with large savings.
The interest rates may be the same as tracker, standard rate or fixed rate mortgages, but you can improve the rates with the amount of savings you have. Generally, you will need at least 10% of the mortgage amount in savings to save money in the long run.
Sharia mortgages, or Islamic mortgages, exist because Islamic banks are not allowed to charge interest due to religious guidelines. However, there are a few different ways that they can offer mortgages whilst making a profit by not charging interest. These include: ijara, which involves renting the property out for a period of time; diminishing musharaka, which involves a temporary co-ownership agreement with the bank; and murabaha, which involves buying the property from the bank for a profit. You do not need to be Muslim to apply for these types of mortgages.
What Fees Will I Have to Pay?
There are a certain amount of fees and charges that you may need to pay when arranging a mortgage or at a later date. These include
- Arrangement fee (can be as high as £2,000)
- Booking fee (usually between £200 and £300)
- Mortgage admin fee (usually between £100 and £300)
- Property survey (usually between £400 and £500, but can be as high as £1,000)
- Mortgage broker fee (can be as high as £500)
- Solicitor fees (which includes property searches, usually between £1,000 and £1,500)
- Stamp Duty (a percentage of the property value paid as tax)
- Late or missed payment charges
- Early repayment charges
- Leaving the mortgage arrangement charges
The fees and charges you pay will differ depending on your requirements and what services you use. You may be able to pay for some of the fees, like the arrangement fee, as part of the mortgage. But this could increase the amount of interest you pay over the mortgage term, as it will increase the loan amount.
What Happens if I Miss Mortgage Payments?
Your lender will usually have a policy for what happens if you miss mortgage payments. You should make sure to read this when you apply, so you’re prepared if you find yourself in that situation.
If you miss a payment, the lender will contact you in the first instance to try to come to an agreement to repay what you missed. Usually, this will be over an acceptable period of time and not all at once. It could involve extending the mortgage period, arranging a different type of mortgage or temporarily pausing interest payments. Both parties will want to avoid repossession (when the lender takes back the house), so it’s best to speak to your lender as soon as possible if you haven’t been able to pay back mortgage payments.
If you are unable to come to an agreement, your home will be repossessed. For this to happen, you would have had to have missed payments twice within 12 months and the lender must have made an attempt to offer you a chance to repay.
If your home is to be repossessed, you can either surrender the property voluntarily or you’ll be taken to court. A court-ordered repossession will often involve more fees.
The lender will eventually sell the property to recover the outstanding loan amount and any fees they took on from selling. You will be given any excess money that is received from the sale after the lender’s costs have been covered.
Can I Pay Off My Mortgage Early?
You can pay off your mortgage early and doing so could save you money, as you’ll end up paying less interest. However, if you have other debts such as a personal loan or credit card, it may make more sense to pay these off first. They are likely to have higher interest rates than your mortgage.
How you pay off your mortgage early will depend on the terms of your mortgage. You may be able to overpay by increasing how much you pay each month. Not all mortgages allow you to overpay in this way though, and you will usually find you can’t overpay anymore than 10% a year with lenders that do allow it. Some lenders may charge you a fee for overpayment.
You can sometimes pay a lump sum to repay whatever is left on your mortgage. If you are able to do this, you might have to pay an exit fee. It can sometimes be more expensive to pay off in a lump sum than overpaying gradually.
Can I Transfer My Mortgage if I Move House?
If you are moving house, you will probably be able to move the mortgage with you. This will mean that the mortgage will then be secured against your new property, instead of your original home. However, you may need to go through the mortgage application process again if you need to make any significant changes to the mortgage, like borrowing more money. Your new property will be valued by the lender to make sure it can cover your mortgage.
You may want to look at other mortgages to see if you can get a better deal. However, you may be charged a substantial fee to transfer your mortgage to a new provider. You should check your mortgage terms carefully and always get advice if you’re unsure.
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