Mortgages made simple
Should you get a tracker mortgage or a fixed rate mortgage? What are LTV, APR, SVR, base rate and early repayment charges? Getting a mortgage can be daunting, and the amounts of money huge. Understanding the basics about mortgages is an important step when buying a home
How much can I borrow?
- How much you can borrow from a mortgage company depends upon your annual income, debt levels, and fixed outgoings like child-care
- This is because you pay back your mortgage over a number of years and mortgage companies want to ensure you can continue to repay them
- Different banks will lend you different amounts.
- The best way to work out exactly how much you can borrow is to ring up a mortgage broker or mortgage lenders and ask them to give you an estimate of how much they can lend you. They can give you an indication of what you can borrow taking into account your monthly household budget.
- The mortgage calculator on our mortgage services page can also give you a rough guide of how much you can borrow although it doesn’t take into account your specific household expenditure items.
How long do I borrow it for?
- The term of the mortgage varies, but by far the most common is 25 years
- Other common terms are 10, 15 or 20 years. Some mortgages have been arranged for 100 years, meaning they won’t have to be repaid for a century
- The shorter the term of a “repayment mortgage” (see below for more details), the higher your monthly payments will be. This is because you will have fewer years to pay off the loan, and so will have to pay more each month
- On the other hand, the shorter the term of the mortgage, the less interest you will be paying in total, because you will have had the debt for a shorter time. If you can easily afford the monthly payments, it is cheaper overall to go for a shorter term mortgage
- At the end of the mortgage term, you have to repay the whole loan (with a repayment mortgage you will already have done this, over time)
Your house is used as a guarantee of the mortgage
- Lenders require that the mortgage is secured against your property, to ensure that if you cannot pay they don’t lose their money
- If you fall behind in the mortgage payments, then the mortgage lender can force you to sell off your home to pay off the mortgage
- If you sell the house before you have finished paying off the mortgage, you will have to use the money from the sale to pay it off, and then you keep the difference
- The lender will normally keep the title deeds of the property as a guarantee, and their interest in the property is lodged with the Land Registry
What is negative equity?
- Someone is said to have negative equity when the value of their mortgage is greater than the value of their property
- Negative equity usually happens when people had very high LTV rates (for example, over 90%) when they bought, and then house prices fell
- If you have negative equity, you cannot sell the house to pay off the mortgage. This means you can be trapped in the property, and only leave once you have paid off the mortgage in full, or if you declare yourself bankrupt
- The government has been pushing mortgage lenders to offer “portable negative equity”, which means that homeowners can still move to another property. They will still be in negative equity, but will have been able to move
- Once property prices start rising again, then people are gradually lifted out of negative equity if they wait long enough
Are there additional costs of mortgages?
- There are various other fees associated with taking out a mortgage, which can add many thousands of pounds to the cost – a valuation survey of the property, legal fees and arrangement fees
- Mortgage lenders will sometimes pay these fees for you, particularly if they are trying to attract you as a new customer
- If you are taking out a mortgage with a high loan to value ratio (see below) you may be charged a mortgage indemnity fee which is usually used to cover the cost of insurance on their loan to you
- Mortgage lenders will often be prepared simply to add these fees to the total for the mortgage, so you pay them off over time
- Mortgage lenders should tell you what the fees are upfront, but you should make sure you are fully aware of them so you don’t get any nasty surprises
- You might also have to pay early repayment charges, if you pay off part of your mortgage early. These early repayment charges can be very high if you have a discounted or fixed rate mortgage (see below for more details)
Putting down a deposit
- You also have to pay for a proportion of the property up front. This is called putting down a deposit
- You will usually have to put down at least 10% of the value of the property. For some mortgages you will have to put down much more
- How much deposit you put down will not usually affect how much mortgage companies will lend you, but it can affect the interest rate they charge
- The more deposit you put down, the lower your LTV or “loan to value” ratio. This is value of the loan as a percentage of the total value of the property. For example, a £100K property with an £80K mortgage has an LTV of 80%; a £500K property with a £100K mortgage has an LTV of 20%
- Generally, higher LTVs lead to higher interest rates, because they are seen as riskier for lenders. For example: if you put down 90% of the value of a property as deposit, and borrowed only 10%, your interest rates would probably be lower than if you put down 10% of the value of the property as a deposit and borrowed the other 90%
- The amount of the property you own that is not covered by a mortgage is known in the jargon as “equity.” If you have a £300K home, with a £200K mortgage, then you have £100K of equity in the property
Repayment or Interest only?
The standard type of mortgage is repayment:
- Each month you pay back a part of the mortgage loan (called capital repayments), and the monthly interest
- At the beginning of the mortgage term, when the mortgage is larger, most of your monthly payments will comprise interest; further along, as you have started paying off the mortgage and the monthly interest is less, then most of your monthly payments will be repaying the capital
- By the time your mortgage term ends you will have paid back all the loan, plus the interest
An interest-only mortgage can be more affordable on a monthly basis, but you still need to pay it off at the end:
- You only pay back the interest each month, and don’t make capital repayments. This means the monthly payments are considerably less than a repayment mortgage
- You can make your own capital repayments during the term of the mortgage to reduce the size of the loan, but beware that the lender might require you to pay early repayment charges if you do this
- At the end of the mortgage term, you still need to pay the loan off. If you haven’t made any repayments, you will need to repay the entire value of the mortgage at the end of the term
- Lots of people get trapped because they haven’t arranged a way to pay the loan off
- Generally, lenders will only give you an interest only mortgage if you have a higher annual salary and have put in a higher deposit and indeed it is becoming increasingly difficult to take out an interest only loan
What are fixed rate, standard variable rate, and tracker mortgages?
- A tracker mortgage follows the Bank of England’s base rate plus a certain percent
- The base rate is a rate of interest that the Bank of England sets
- Tracker mortgages are simple and transparent – you can see how much the bank is charging, and know that your monthly payments will only go up and down because the Bank of England has changed its rates
- For example, if base rate is 0.5% and you get a mortgage that is 2% above base rate you will pay interest of 2.5%. If base rate increases to 1% you will pay interest of 3%.
Standard variable rate mortgages
- This is the lenders’ standard mortgage, without discounts, fixes etc
- The standard variable rate is the lender’s own basic interest rate at which it lends mortgages (invariably higher than the Bank of England base rate)
- It is a rate set by the lender. They decide if and when it goes up and down, which they do to ensure they make a profit, and in reaction to how much it costs them to borrow on the international money markets
- It is not transparent to borrowers how the lenders set their SVRs, which they can change even if the Bank of England hasn’t changed base rates. The SVR can also stay the same even when the Bank of England has cut base rates
- However, SVRs are generally kept low by market competition, since you can leave and get a mortgage elsewhere if the lender starts charging you too much interest
Fixed rate mortgages
- A fixed rate mortgage has a set interest rate for a certain period
- Normally it is fixed for the first 2, 3, 5 or occasionally 10 years
- Regardless of whether the Bank of England base rate or the SVR goes up or down, you will still pay the same interest each month
- When you finish your period of grace, you will revert to a tracker or SVR mortgage
- Between 50% and 75% of mortgages taken out in the UK are fixed rate