Over our years of experience we have learned that while most people understand the idea of a mortgage, they are often overwhelmed by the complexity of the different products. Fortunately, once you know the basics it’ll narrow down your choices and make it a lot easier.
What is a mortgage?
In simple terms, a mortgage is a loan taken out when you want to buy land or property. If you don’t keep up with the repayments under its terms, the lender could repossess your house and sell it to pay off your loan.
So, choosing the most appropriate mortgage for your needs is vital. All mortgages run for a certain amount of time – the usual term is 25 years, but this can be shorter or longer depending on your needs.
Can you get a mortgage?
Your ability to get one depends on the thorough checks most lenders will carry out to work out whether you’ll be able to afford the repayments to pay back the amount you’re borrowing.
These checks are based on a few different factors, which will give a numerical score known as a Credit Score. They include:
- Online credit reports that look into all your credit agreements, past addresses you’ve lived at and your past and current financial arrangements
- The information you supply on your application form for the mortgage
- Any business you may have carried out with the lender previously
- The activity on your bank account
Lenders are looking for a high credit rating as that represents the lowest risk for them.
Mortgage lenders also have to carry out new affordability checks, recently introduced by the Financial Conduct Authority. These checks will look at your income and everyday spending habits to work out whether you can afford to cover the repayments.
To help you plan ahead, here’s what you’ll need to provide:
- Prove how much you earn using payslips or tax returns. If you have more than one job, you’ll have to do this for all of them.
- If you’re self-employed you can use accounts and projected earnings to prove how much you earn.
- Provide proof of other sources of income, such as shares, pensions and bonuses.
- Confirm your spending – this means the amount you spend on essentials (food, cleaning, council tax, bills), quality of living (clothes, personal items, entertainment) and any loans you already have.
Most people know you’ll need to provide a deposit to get a mortgage. Usually a deposit of around 10% of the property’s value is needed, but there are situations where you can pay as little as 5% deposit. This will depend on the type of mortgage you choose and your own circumstances.
Choosing your mortgage
Some of the most important things to look at when choosing a mortgage are the repayment method, the different types of mortgage available, the interest rate you’ll be charged and the total amount you’ll need to repay
You’re looking for the repayment method that’ll work best for you.
Interest only mortgage
These mortgages are now only offered with very strict criteria and aren’t available to everyone. With an interest only mortgage, you only pay the interest charged on your loan, so you’re not actually reducing the loan itself. You need to have a realistic repayment strategy in place to repay your loan at the end of the term – for example investments and savings. Lenders will want to see proof of these. Remember, very few savings plans and investments are guaranteed to repay your mortgage in full. If your savings or investments don’t cover the full amount, you’ll be responsible for paying the difference.
Your monthly payments to your lender go towards reducing the amount you owe, as well as paying the interest they charge. This means that each month you’re paying off a small part of your mortgage. You can see your mortgage getting smaller and provided you maintain the required repayments, you also have the certainty that your mortgage will be repaid at the end of the term.
Here’s an overview of some of the most common types of repayment mortgage available, to get you started:
STANDARD VARIABLE RATE (SVR) MORTGAGE
This is the lender’s default rate for mortgages. The interest rate changes depending on market rates, such as the Bank of England rate (their rate for lending to other financial institutions). This means repayments can go up and down too. It’s not usually the most competitive, so you won’t necessarily be getting the best deal on the interest rate.
FIXED RATE MORTGAGE
If you choose a fixed rate mortgage, your monthly payment will stay the same for a set period – usually 2, 3 or 5 years. You know the exact amount you’ll need to pay every month, which makes budgeting easier, and your payment will stay the same even if other interest rates increase. On the other hand, this means you don’t benefit if interest rates fall and you may need to pay an early repayment charge, or other charges, should you want to make changes. At the end of the fixed rate period, your lender will usually change your interest rate to their SVR.
DISCOUNT RATE MORTGAGE
Some mortgages start with an initial interest rate that is lower than the SVR for a set period of time. Your payments could be less in the early years, when money may be tight, and they’ll go up or down which can make budgeting difficult. You must be confident that you can afford the repayments when the discount ends. At the end of this period, your lender will change the interest rate to the SVR.
This is where the interest rate is linked to market rates like the Bank of England’s base rate. These can offer lower rates than a fixed rate mortgage but your payments could rise (or fall) and you need to be prepared if they do.
Usually links the savings in your main current and/or savings account to your mortgage debt with the same lender. As the account balance goes up, your mortgage interest payments come down and vice versa. Remember you don’t earn interest on your savings in the linked accounts. If you don’t have much saved in those linked accounts to offset the mortgage with, it may not be worth it as the interest rates can be higher than those on other mortgage products.
CAPPED RATE MORTGAGE
The interest rate is linked to a lender’s SVR but with a guarantee that it won’t go above a set level (called a cap). You know the maximum you’ll pay for a set period of time making budgeting easier. The cap generally lasts for 2-5 years and then the mortgage will go onto the SVR or tracker rate for the rest of the term.
In terms of interest rates, you’ll need a rate that not only suits your current financial situation, but also how you see your finances developing over the next 5, 10, and 25 years.