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Understanding Mortgages: How do they work and how to get one

Moving House Checklist > Understanding Mortgages

Unless you’re an experienced homebuyer or an estate agent, the concept of a mortgage is a scary thought.

You’ve probably heard a few of your mates talking about mortgages; listening on in envy and confusion. You’ve nodded your head in agreement when they talk about the astronomical figures, only to realise that you should be shaking it in astonishment.

But mortgages are something you should know about, particularly if you’re seriously considering buying a property.

Why do you need a mortgage?

To put it bluntly: you need a mortgage to buy a property. Of course, there are occasions when this isn’t true (e.g. you have enough money to buy a property outright). But, in general, mortgages are the key to getting your keys.

Buying a home is likely to be the largest purchase you will ever make. It’s an investment that requires a lot of time, effort and money. For this reason, you need to know everything about the process and all the components involved. The most import of which is the mortgage.

If you’re unsure of what a mortgage is; don’t worry. We’re going to explain everything you need to know about it. We’ll cover what a mortgage is and explain the different types.

So, what is a mortgage?

A mortgage is a loan that you take out with a ‘lender’ to buy a property. 

The term of the loan is usually 25 years, but it can be shorter or longer depending on the agreement and your financial situation.

The mortgage is secured against your home and is paid off over time. Once it is paid off, the property – as a whole – belongs to you. However, if you can’t keep up with your payments, the lender is allowed to repossess your home and re-sell it to make their money back.

Before you get a mortgage, you need to work out what you can afford and how much you can borrow.

How much can you afford to borrow?

It’s easy to fall into the trap of reaching for the stars. After all, a bigger mortgage means a bigger house, right? 

However, you need to tread carefully.

While a big mortgage will give you more money to play with, your repayments will be higher. Rather than stretch yourself and struggle to keep up with the repayments, think logically and be prepared to compromise.

It’s important to remember that mortgage repayments aren’t the only costs associated with owning a home. On top of your monthly mortgage fees, you will still have to pay for the running costs of owning a home, such as utility bills, council tax and general maintenance.

Applying for a mortgage

There’s an old saying that ‘those who fail to prepare, prepare to fail.’ When applying for a mortgage, you need to be prepared and have all your paperwork ready.

Mortgage lenders will ask you a lot of questions before they agree to the loan. They will want to see proof of income and will ask about your monthly expenditure and any outstanding debts.

They will also ask for information regarding bills, children and personal expenses. This could be as minimal as a gym membership or phone contract.

It’ll feel like an interrogation, but it’s a necessary hurdle. Lenders need proof that you are who you say you are. They also need to be sure that you have the financial capacity to pay your loan back, even if interest rates rise.

Failure to provide the necessary documents and identification could lead to a lender refusing you a mortgage.

Banks, Building Societies and Brokers

There are a few different avenues you can go down to get a mortgage. Banks and building societies will offer different rates and offers, so do your research and find the mortgage that works for you.

If you’re worried about doing it on your own, you can hire a mortgage broker or financial advisor to assist your and compare the different options on the market. These professionals have contacts in the industry and can access mortgages that are not available to other customers.

Some independent brokers will look at offers from across the market, while others will only look at mortgages from particular lenders.

An insurance broker will charge a fee. However, they can also save you money on your repayments, so they might be worth the initial outlay if you have the funds available.

Any trustworthy broker will be open about their fees when you contact them. They should be able to tell you what services they offer and how much it will cost. It’s a saturated market, so do your research and don’t be afraid to turn a broker down if something doesn’t feel right.

Whichever route you decide to go down – whether you choose to go straight to a lender or a broker – do you research and take your time. Buying a property is an investment, so you must get it right.

What is a deposit?

‘Deposit’ is a word that strikes fear into home buyers. You’ve probably heard it mentioned, and you most likely understand the principle. But we’ll still give you a quick rundown of what a deposit is and how it works. 

When you buy a property, you have to pay a percentage of the purchase price yourself. This is known as the deposit.

The amount of deposit required to take out a mortgage is worked out as a percentage against the value of the property you’re buying. The mortgage loan is then calculated on the amount of money left to pay.

To put this into less confusing terms, let’s say that you’re buying a property for £234,000 – which the average price for a property in the UK. 

If you were to pay a 10% deposit on the property, you would need to have £23,400 ready to put down in an instant. This would mean that the remaining £211,000 is covered by your mortgage, which you will pay off over time.

10% is the figure that tends to be thrown around when the subject of deposits arises, but the amount you put down can vary.

The minimum deposit can be 5%, meaning you get a 95% mortgage. This may sound like an appealing and cheap way to get on the property ladder, but it does come with its pitfalls.

Interest on your mortgage

As your mortgage is a loan, it attracts interest and inflation. By having a larger deposit, you attract less interest on your mortgage, making it more manageable and keeping your repayments under control. 

Mortgages with lower interest rates are only available to those buyers with larger deposits. For example, a 20% deposit will get you a mortgage with a lower interest rate than a 10% deposit, meaning you pay off less money in the long run. 

A 20% deposit is the recommended figure as it gives you access to better mortgage offers. But, if you are struggling to find the money to make that milestone, a 10% option is worth exploring.  

It’s also worth remembering that you only get access to better deals when you go up by 10%, 15%, 20% and so on. There will be no difference in interest rate between a 15% deposit and a 17% deposit. 

Once you’ve worked out your deposit, you will then have to get your hand around the phrase ‘loan to value’.

Understanding Loan to Value

Loan to value – or ‘LTV’ – is a method of working out how much you’re borrowing compared to the total price of the property.

The sum is worked out using percentages and you should be aiming for a figure of around 80%.

To work out the LTV, you need to have the house price, your deposit and the amount your mortgage is for. Then, you just need to subtract the deposit from the house price and divide your mortgage by your house price and multiply it by 100.

Again, to make this easy, let’s do an example.

The average house price in the UK is £234,000, making the recommended deposit £46,800 (20%).

Your mortgage can be worked out by subtracting the deposit from the house price, so: £234,000 – £46,800 = £187,200

Then you divide your mortgage by the house price £187,200 / 234,000 = 0.8.

Finally, multiply 0.8 by 100 and you get the final percentage = 80%

A lower LTV will mean a better interest rate. It also means that you need to put down a higher deposit on the home. 

Types of mortgage

There are two main types of mortgages in the UK: Fixed Rate and Variable Rate. You must understand both to work out which one you’d prefer and what you are being offered by your lender. 

Fixed-rate mortgages

A fixed-rate mortgage means that your interest rates will stay the same throughout the length of the deal, no matter what happens to the markets. 

They tend to be offered as a two-year fix or a five-year fix and the lender explain the interest rates that will be offered during that period. 

Some people like the safeness that comes with a fixed-rate mortgage. This type of mortgage offers a degree of peace of mind, as your monthly payments will stay the same throughout the deal, making it easier to budget. 

That said, the interest rates on a fixed-rate mortgage tend to be higher than what you might find on other mortgages. You will also not be offered lower interest rates if they fall and cannot leave the agreement during the length of the deal. 

You should keep an eye out for the end of the deal and think about moving to a new provider once it ends. You lender will automatically move you onto a variable rate mortgage, which may not work for you. 

Variable-rate mortgages

The interest on a variable rate mortgage can change at any time. This can be both a positive and a negative thing, as you may get to enjoy a lower interest rate if they fall. 

However, it’s also recommended that those with a variable rate mortgage have savings set aside in case interest rates increase and impact your repayment plan.

Unlike a fixed-rate mortgage, you are free to leave a variable rate agreement at any time and switch to another provider if you see a better deal. This degree of flexibility appeals to people who like to shop around for a good deal. 

Right to Buy Mortgages

There are other types of mortgage agreements to be aware of, such as the Right to Buy scheme.

Right to Buy is a government scheme that has been designed to help those living in council housing to buy their homes with a large discount. 

The discounts are usually offered against deposit costs, meaning that those who can afford a mortgage may be able to purchase a property with no deposit at all.

The size of the discount is dependent on the length of time you’ve lived in the property, the type of property and the property’s value. The maximum discount available is £103,000 in London and £78,000 in the rest of the country. 

To qualify for the Right to Buy scheme, you need to have been a public sector tenant for three to five years. You do not have to have been in the same property for that time, you just need to have accrued the right amount of time in public sector housing throughout your life. 

Help to Buy: Shared Ownership Scheme

Another way to get on the property ladder is through the Help to Buy: Shared Ownership scheme. 

The scheme is designed to help those who can’t quite afford the mortgage on 100% of a property. Under the scheme, you can buy a share of the property (between 25% and 75% of its value) and pay rent on the remaining shares. You can then buy bigger shares of the property when you can afford to.

Help to Buy: Shared Ownership is only available to a particular group of people. Your household can not be earning more than £80,000 a year outside London, or £90,000 a year in London.

To qualify for the scheme, you need to be a first-time buyer, someone who used to own a home but can’t afford to buy a new one or are an existing shared owner looking to move.

Help to Buy: Shared Ownership applies to new build homes or existing properties that are sold through Help to Buy resale programmes from housing associations. You will need to take out a mortgage for your share of the property and you will be required to keep up with the repayments.

It’s also worth remembering that the government will take their percentage of the earnings when the property is sold, no matter if the value rises during your ownership. 

There are other mortgages available, such as a guarantor mortgage, but they are becoming an increasingly rare option.

So that’s everything you need to know about mortgages.

While they seem like a daunting proposition, mortgages are scarier than they sound. 

There’s a lot of money involved, a lot of variables and some percentages to get your head around. But you’ve just got to remember that they’re a key component of buying a property.

Besides, if so many people have one, it can’t be that difficult to understand, can it?


Published at Mon, 06 Jan 2020 10:00:20 +0000