Finding your dream home is an exhilarating milestone, but navigating the mortgage process can feel overwhelming. From interest rates to deposits and contracts, there's plenty to wrap your head around. Let's unravel the complexities and empower you with the knowledge you need to embark on your house-hunting journey with confidence.
Mortgages are financial services offered by financial institutions that help people buy a house or other property.
They are usually paid over long periods of time, with 25-year terms being the average.
Mortgages require borrowers to pay interest rates on the loan amount, which can be fixed or variable.
The cost of the interest paid on a mortgage is affected by multiple factors, including the deposit, the loan-to-value ratio, the length of the mortgage, etc.
Borrowers can take action and ensure they get the best deals with the lowest interest rates when applying for a mortgage.
Mortgages Explained
A mortgage is a type of loan designed specifically for the purpose of buying a house or other property.
What’s noteworthy about them is that when a borrower applies for a mortgage, they need to put down a percentage of the value of the property they are trying to buy as a deposit. The rest of the property’s value is covered by the lender, who provides the mortgage.
This means the borrower doesn't own the property outright until the mortgage is fully repaid. The property serves as collateral for the loan, which means that if the borrower fails to make mortgage payments, the lender may have the right to foreclose on the property and sell it to recover the outstanding debt.
What is a “term”?
Another characteristic of mortgages is the long loan periods, typically ranging from 25 to 35 years, allowing borrowers to spread out their payments over an extended period. This allows them to have lower monthly payments, making homeownership more affordable and manageable. However, it also means that borrowers will end up paying more in total interest over the life of the loan compared to shorter-term loans.
To sweeten the deal, mortgage lenders usually offer mortgage deals to borrowers, giving them favourable interest rates for the initial few years of the loan term. After the initial period, the interest rates will adjust to the prevailing market rates or the terms of the mortgage agreement.
There are a few things that borrowers can do to get the best mortgage terms available to their financial situation. This article will explain everything you need to know about how mortgages work and how to improve your chances of getting a favourable mortgage.
How do deposits work?
As mentioned above, making a down payment is necessary when applying for a mortgage. This down payment is known as the deposit.
Naturally, the more you can put towards the value of the property as a deposit, the less you will need to borrow. For example, if the property you are interested in buying costs £200,000 and you deposit £20,000, you already cover 10% of the total value of the property, and the lender will cover the remaining 90%. In other words, your mortgage will have a 90% loan-to-value (LTV) ratio.
The size of your deposit is an important factor to consider when applying for a mortgage, as in addition to borrowing less, lower LTV ratios generally lead to better mortgage terms and more favourable interest rates.
Borrowers who can provide a larger deposit pay lower monthly repayments and less interest on their mortgages, and the stats suggest Brits are aware of this fact. Even though most lenders have low minimum deposit requirements of only 5%, according to the latest data, the average UK first-time homebuyer deposits £61,000, which is about 26% of the average house price of £236,783.
Where Can You Find a Mortgage?
With numerous lenders and financial institutions competing for business, borrowers have a multitude of options when it comes to finding the right mortgage. In addition to high street banks and building societies, there are also specialist lenders and credit unions that can provide mortgage services.
Moreover, borrowers can look for mortgage deals on online mortgage marketplaces or engage mortgage brokers that can help them navigate the market and find suitable options.
High Street Banks
High street banks are traditional financial institutions that offer a wide range of financial services, including mortgages. They have a physical presence in local communities and often have established reputations.
The pros of obtaining a mortgage from a high street bank include their familiarity, accessibility, and the potential for bundled services such as current accounts and savings accounts.
However, their mortgage products may have stricter eligibility criteria, limited flexibility, and may not always offer the most competitive rates.
Building Societies
Building societies are financial institutions which are owned by their members and operate for their benefit. They offer savings accounts, mortgages, and other financial services.
Building societies are known for their focus on customer service and may offer more personalised attention compared to high street banks. They often have competitive rates and flexible mortgage products.
That being said, building societies typically have limited branch networks, which can impact accessibility for some borrowers.
Specialist Lenders
Specialist lenders cater to specific segments of the mortgage market. They may focus on niche markets such as self-employed individuals, borrowers with adverse credit histories, or those looking for buy-to-let mortgages.
These lenders often have more flexible eligibility criteria and may be more willing to consider unique circumstances.
Their main drawback is that their interest rates may be higher, and they may have stricter terms and conditions compared to mainstream lenders.
Credit Unions
Credit unions are member-owned financial cooperatives that offer savings accounts and loans, and some of them even offer mortgages to their members. They are community-based and often have a focus on social responsibility.
Just like building societies, credit unions can provide more personalised service and may offer more competitive rates. Though, their product offerings may be more limited, and eligibility requirements can vary depending on the specific credit union.
Online Mortgage Marketplaces
Online mortgage marketplaces are platforms that allow borrowers to compare and apply for mortgages from multiple lenders. These platforms provide access to a wide range of mortgage products, making it easier for borrowers to compare rates, terms, and features.
The advantages of using online mortgage marketplaces to find a mortgage include convenience, transparency, and the ability to explore a wide range of options.
However, borrowers should ensure the marketplace is reputable and take precautions to protect their personal and financial information.
Mortgage Brokers
Mortgage brokers are professionals who help borrowers navigate the mortgage market. They have access to a wide range of lenders and can provide personalised advice and assistance in finding the right mortgage.
The main advantage of using a mortgage broker is their expertise and ability to find tailored solutions. Brokers can help borrowers understand their options, compare rates and terms, and handle the paperwork involved in the mortgage application process.
One thing that borrowers should be aware of is that some brokers may charge fees for their services, while others may have relationships with specific lenders, limiting the range of options presented.
The Cost of Mortgages
The cost of mortgages is determined by several factors that are considered by lenders when offering a mortgage to a borrower. Here are the key factors that influence the cost of mortgages:
Interest rates – The interest rate is a key factor that determines the cost of a mortgage. It represents the cost of borrowing money from the lender and is typically expressed as an annual percentage.
Loan amount – The amount borrowed, known as the loan amount or principal, directly impacts the cost of the mortgage. A higher loan amount means more interest will be charged, resulting in higher overall costs.
Loan term – The duration of the mortgage, often referred to as the loan term, influences the total cost of the mortgage. In general, a longer loan term results in lower monthly repayments but higher overall interest costs, while a shorter loan term leads to higher monthly repayments but lower overall interest costs.
Deposit – As we already mentioned, lenders may adjust the interest rate based on the LTV ratio. A higher LTV ratio may result in a higher interest rate and potentially increased costs.
Creditworthiness – Lenders also assess the creditworthiness of borrowers by considering factors such as credit scores, credit history, income, and affordability. Borrowers with stronger credit profiles typically have access to lower interest rates, potentially reducing the overall cost of the mortgage.
Mortgage type – Different mortgage types, such as fixed rate, variable rate, or tracker mortgages, have varying cost structures. Fixed-rate mortgages offer a stable interest rate for a specific period, while variable rate mortgages can change over time based on market conditions or the lender's discretion.
Additional charges – Lenders may apply various fees and charges, including arrangement fees, valuation fees, legal fees, and early repayment charges. These additional costs can impact the overall cost of the mortgage.
Once the loan amount, loan term, and interest rates are known, the monthly repayment and total mortgage costs can easily be calculated, excluding the extra fees.
How Do Mortgage Payments Work?
A monthly repayment, also known as a mortgage payment, is the amount of money a borrower pays to the lender each month to repay their mortgage loan. It consists of two main components:
Capital – A portion of the monthly repayment goes towards reducing the capital or principal amount that was initially borrowed. As the borrower makes regular payments, the outstanding loan balance decreases gradually.
Interest – The remaining portion of the monthly repayment covers the interest charged by the lender for borrowing the money. The interest is calculated based on the interest rate specified in the mortgage agreement.
A mortgage payment example
For example, let’s say that you borrowed £200,000, on a loan term of 25 years, and at an interest rate of 5%. Over the course of the entire mortgage lifetime, you will pay a total interest of £150,754.
Add the £200,000 capital to the £150,754 interest, and you get your total mortgage payment cost of £350,754. Divide it by 300 (25 years * 12 months in the year), and you will get your monthly repayment of £1,169.18.
Mortgage payments work like this because, in the early years of your mortgage lifetime, your monthly payments mainly cover the interest, and only a small chunk goes to paying off the capital. But as the capital gets paid off, the interest gets smaller and smaller.
Continuing with the example above, a monthly repayment of £1,169.18 adds up to £14,028 per year. In the first year of your 25-year loan term, £9,906 will cover your interest, and only £4,124 will be used to pay off capital. Conversely, in the last year of your mortgage, only £373 will be interest payments, and £13,658 will be used to cover the capital.
How Long Will I Have to Pay Off a Mortgage?
The average duration to pay off a mortgage in the UK is 25 years, but it's important to note that individual circumstances and preferences can lead to different choices and outcomes.
A 25-year loan period means that you will make monthly payments for 25 to pay off your mortgage, though the actual time it takes to pay off a mortgage can be shorter or longer depending on various factors, such as:
Early repayment – If you can make additional payments towards the principal, you can potentially pay off the mortgage sooner than the agreed-upon term. By reducing the outstanding balance, you can save on interest costs and shorten the repayment period.
Remortgaging – Some homeowners may choose to remortgage their loan during the term. This involves switching to a new mortgage product, potentially with a different interest rate or term. It can result in a different duration to fully repay the loan, depending on the new terms agreed upon.
Variable interest rates – When using an adjustable-rate mortgage (ARM) with an interest rate that can change over time, the duration to pay off the mortgage can be influenced by interest rate fluctuations. Changes in interest rates can affect the monthly payment amount and potentially extend or shorten the repayment period.
Additionally, some borrowers may choose shorter mortgage terms, such as 15 or 20 years, to expedite repayment and save on interest costs. Others may opt for longer terms, such as 30 years, to have lower monthly payments but a longer repayment period.
Overpaying your mortgage means making additional payments towards the outstanding balance of your mortgage loan, beyond the monthly repayments. There are a few benefits to overpaying your mortgage:
Paying off the mortgage sooner
Saving on interest payments
Building better LTV will give you better remortgaging options
However, it’s worth noting that some lenders charge overpayment fees that may complicate things. Weight out your options and determine whether or not overpaying your mortgage is the right choice for you and how much you should overpay if you decide to do it.
What Type of Mortgage Do I Need?
As you may be aware, there are multiple types of mortgages available on the market, and they are all designed to be more suitable to a specific financial situation. Let’s look at some of the most popular options and see which one fits you best.
Fixed Rate Mortgages
Fixed-rate mortgages have an interest rate that remains unchanged for the duration of the deal period, after which they switch to the standard variable rate (SVR). They provide stability and predictability, as market changes don’t affect them. They’re ideal for first-time buyers and cautious people who prefer consistent monthly payments and want protection against interest rate fluctuations.
Tracker Mortgages
Tracker mortgages have an interest rate that moves in line with the Bank of England's base rate or another specified interest rate. This means that when the tracked rate increases or decreases, so does the mortgage rate. Tracker mortgages are suitable for borrowers who are willing to take this risk and hope the rates will drop, but also pay more if they rise.
Variable Mortgages
Similar to tracker mortgages, variable mortgage rates can go up and down, though they are not influenced by any base rate and are left at the lender’s discretion. As such, they are only suitable for borrowers who can afford to take big risks.
Guarantor Mortgages
Guarantor mortgages involve a family member or close relative providing a guarantee for the mortgage repayments. This can help individuals who have a limited deposit or income to secure a mortgage. The guarantor is liable for the repayments if the borrower defaults.
Offset Mortgages
Very popular with self-employed borrowers, offset mortgages link your savings and current accounts to your mortgage. The balance in these accounts is offset against your mortgage debt, reducing the interest charged. For example, if your mortgage is £200,000, and you have £50,000 in your savings, you only pay interest on £150,000.
Interest-Only Mortgages
The other types of mortgages fall into the category of repayment mortgages. It’s worth noting that in addition to them, there are also interest-only mortgages where the monthly payments only cover the interest charged on the loan, and the capital is paid at the end of the mortgage term.
Interest-only mortgages give borrowers more financial flexibility with lower monthly payments during the mortgage term. However, at the end of the term, the borrower must pay the capital either with a repayment vehicle or a lump sum.
How Can I Improve My Chances of Getting a Mortgage?
While the chances of getting a favourable mortgage deal ultimately depend on your personal circumstances and lender criteria, there are a few best practices that can help you get the best mortgage available:
Understand that each lender has different criteria, so research multiple lenders and compare their offerings.
Obtain your credit report and work on improving it by paying bills on time, reducing debts, and addressing any errors.
Disassociate financially from ex-partners by closing joint accounts and ensuring they are removed from your financial records.
Demonstrate responsible credit management by paying bills promptly, avoiding late payments, and keeping credit utilisation low.
Save for a larger deposit, as a larger down payment can increase your chances of securing a mortgage and potentially lead to better interest rates.
Avoid new credit applications shortly before or during the mortgage application process, as it can raise concerns for lenders.
Get pre-approved before house hunting to get a clearer understanding of your budget and demonstrate your seriousness as a buyer.
Finally, consider getting professional advice from a mortgage broker, as their expertise can be valuable in securing a favourable mortgage deal. Mortgage brokers have access to multiple lenders and can help you find the most suitable mortgage options based on your own personal circumstances, so don’t overlook their abilities.
Credit scores are just one aspect lenders consider when evaluating mortgage applications, and multiple other factors determine the mortgage terms.
That being said, according to Experian, borrowers with:
Excellent credit scores (961-999) typically get the best deals on the market
Good credit scores (881 - 960) can qualify for most, but the best mortgage deals
Fair credit scores (721 - 880) are eligible for deals with decent interest rates
Poor credit scores (561-720) can qualify for mortgages with high interest rates
Very poor credit scores (0-560) may have difficulty qualifying for any mortgage
