Mortgage guide

Step 1

What is a mortgage?

Briefly, a mortgage is a loan that is taken out to allow a person to buy a property. The lender, such as a bank or building society, will agree certain terms under which the borrower must repay the money. In the UK, mortgages are typically repaid over 20 to 30 years. A mortgage is ‘secured’ against the property bought, meaning that the value of the property works like a guarantee that the money will be repaid to the lender. Consequently, failure to repay the mortgage can result in the property being repossessed and sold, so that the lender can cover their losses.

There are two parts of a mortgage to be repaid:

• the ‘capital’, which is the money you borrow, and
• the ‘interest’, a fee paid to the lender until the capital is paid back.

There are many different types of mortgage available, and the financial terminology can be a bit of a minefield for borrowers. Interest, offset, tracker, LTV... don’t be intimidated by all the unfamiliar terms. It’s important that you understand the different options available to you before you commit to such a large loan. Our advice is to read up as much as you can about mortgages so that you know what to expect when you go to a lender to ask for specific details.

Step 2

How long will my mortgage last?

Mortgages tend to last between twenty and thirty years – the exact period of time is something that the borrower and lender agree together before the loan is given out. As people are living longer than they used to, mortgages nowadays also tend to be taken out for longer periods of time.

Step 3

What is an interest-only mortgage?

With an interest-only mortgage, the borrower’s monthly repayments repay only the interest on the loan, leaving the full amount of the loan to be repaid at the end of the mortgage period. Though the monthly payments for the borrower are lower, the inability to repay any of the capital means that the borrower must have a plan for how they will repay the rest of the loan. If the borrower cannot pay the full loan amount at the end of the mortgage period, there is the risk of repossession of the property in order to cover the shortfall. Interest-only loans are much higher risk for both the borrower and the lender, and consequently are much harder to obtain now than they used to be.

Step 4

What is a repayment mortgage?

A repayment mortgage involves monthly payments in which the borrower gradually pays off the total amount owed to the lender – both capital and interest. The borrower’s monthly payments are higher than with an interest-only mortgage, but repayments mortgages are much lower risk, as by the end of the term the full amount will have been repaid and there should be no money left outstanding. Most residential mortgages these days are repayment mortgages.

Step 5

What is a buy-to-let mortgage?

A buy-to-let mortgage is what you will need if you are a landlord, or are intending to rent out your property. They are different from residential mortgages because they are not calculated on what you earn, but take into account how much the property will be likely to rent for each month. The rent will usually need to be at least 25% more than the mortgage repayments. Bear in mind that a lender will want to see that you can still make the repayments if the house is empty for a period of time. Another difference from residential mortgages is the fact that you’re more likely to get an interest-only mortgage if it’s a buy-to-let. The interest rates on buy-to-let mortgages tend to be higher, and the deposit needed is likely to be larger than for a residential mortgage – most buy-to-let lenders ask for at least 25% of the value of the property.

Step 6

How much can I borrow?

When you are looking to buy a property, your potential lender will take into account your income, savings, and how much you have available to put down as a deposit on the property. They will calculate your ‘loan to value’ ratio, or LTV, and let you know how much they are prepared to let you borrow. Some lenders will also consider things like bonuses, maintenance payments and tax credits and include those in loan calculations.

Step 7

Which lender has the best deal?

There are a wealth of products on offer, so do your homework and take plenty of time to look into the different options. Your needs won’t be the same as mine – we may get different loyalty offers from our own banks or building societies, for example, or you might have more savings that you can offset against your mortgage. An independent advisor will be able to give you wide-ranging advice that takes the whole market into account – banks and building societies are likely to only tell you about their own products! – but sometimes you can only get the best deal direct from the lenders. Do your research to find out which lender has a product that’s right for you.

Step 8

How can I find the best rate?

Though your interest rate is important, do bear in mind that the rate that you choose is only one of a number of features that affect your mortgage. Broadly speaking, in terms of rates, there are two types of mortgage: fixed-rate and variable rate. As well as what the interest is, you should consider

• the Annual Percentage Rate, or APR. The APR is the cost of fees on top of the quoted interest rate: booking and arrangement fees, valuation fees, etc. Bear in mind that the APR doesn’t take into account any insurance you may want to take out.
• how flexible you will be able to be. For example, will your mortgage allow you to make over payments without charging you a fee?
• the date that a discounted or fixed rate will come to an end. It is likely that fees will apply if you want to switch out of the deal before this date.
• what rate you will switch to once any discounted or fixed rates come to an end.
• whether you will incur any early repayment charges after the initial rate has ended – you should leave yourself the option of switching to a better deal without being charged for it.

• anything else you might pay interest on, like mortgage fees. If you can afford to, paying for your mortgage fees upfront should mean that you don’t end up paying extra interest.

• The maximum loan-to-value (LTV). The maximum LTV is the maximum amount of money that the lender is prepared to lend, and it’s calculated as a percentage of the property’s value. Many sites will take your LTV into account when calculating your mortgage amounts – you can tell if LTV has been taken into account if your mortgage calculate has asked about the property value and the amount you can put down as a deposit.

If you decide that you need advice, an independent adviser will be able to give you an overview of the market. Sometimes the best deals are available directly from the lenders, though, so do your homework and compare your own results with your adviser's recommendations.

Step 9

What other features should I choose?

The range of mortgages on offer can be completely bewildering, especially since it can take some time to get used to all the financial terms. You should do plenty of research when you're considering a mortgage to make sure that you get the best deal for you. Talk to your bank or building society to see what they offer and if you'll get a good deal for being a current customer, but also shop around online and get advice from an independent mortgage broker – an independent advisor will be able to give you an overview of the market.

Take the time to familiarise yourselves with the terms people use to discuss mortgages. Here are a few you're likely to come across:

Rates

• Fixed-rate. The interest rate will stay the same for a set period of time, usually between two and five years, depending on your particular agreement. The advantage of a fixed-rate mortgage is that you know exactly what your repayment will be every month. After the set time, the fixed rate will end.
• Variable rate. There are different types of variable rate mortgages. With a variable rate you benefit from any drops in interest rates, but if interest rates increase, so will your repayments. Bear in mind that interest rates are unlikely to fall in this economic climate – your main concern will be when interest rates increase, and by how much.
• Tracker. A type of variable-rate mortgage. The interest rate of a tracker mortgage follows the Bank of England's base rate at a particular margin, so your interest rate might be +1% of the base rate. Some tracker mortgages follow the base rate for a few years, some for the entire term of the loan.
• Standard variable rate, or SVR. A type of variable-rate mortgage. With an SVR, you pay an interest rate set by the bank. The SVR is usually their default interest rate, which you would revert to when any discounts or fixed-term deals end. A lender may change their SVR at any time.
• Capped. A type of variable-rate mortgage. A capped-rate mortgage places a cap on the interest rate, meaning it will not go above that cap, but it will vary below that cap. Sometimes a capped rate will also have a "collar" meaning that the interest will not fall below a set rate.
• Discount. A type of variable-rate mortgage. With a discounted mortgage, you would pay a set amount below the lender's SVR, so perhaps SVR -1% interest. Discounted rates are usually fixed for a set period of time, and you will generally revert to the SVR when it ends.

Features

• Offset. A feature that affects the interest rates you pay, but does not affect whether the mortgage is fixed-rate or variable. With an offset mortgage, you "offset" the amount of savings you have against the debt of the mortgage you are taking out. So if you're taking out a mortgage of £200,000 and you have savings of £40,000, and you offset those savings, you would only pay interest on £160,000 of your mortgage. It's a very tax-efficient option, as you avoid earning interest and paying taxes on your savings if you use them to offset your mortgage.
• Buy-to-let. A buy-to-let mortgage is taken out on a house that is rented out (or is going to be rented out). It's different to a residential mortgage, but isn't a fully commercial mortgage either. See "What is a buy-to-let" mortgage above.
• Flexible. Depending on the terms, a flexible mortgage may allow the borrower to overpay, underpay or take a "payments holiday" without incurring any early repayment charges or penalties for paying back too much or too little. A flexible mortgage is particularly useful for self-employed people, or those who earn commission or get regular bonuses.

The best advice we can give you is the old favourite: keep calm and carry on! Don't settle for something that's not right for you just because you're fed up of being confused by unfamiliar terms. There is plenty of help available to find the right mortgage for you.

Step 10

What insurance do I need?

You can take out insurance against your repayments, to ensure that your property will not be repossessed if you cannot make payments because you fall ill, have an accident or become unemployed. Thirty years is a long time, and nobody can predict the future! Broadly speaking, there are two different types of mortgage insurance.

• Mortgage payment protection insurance, or MPPI, means that your insurer will pay you a set amount every month so that you can still cover your mortgage payments, usually for a maximum period of one or two years. MPPI is generally less expensive than the alternative, IP, but it only covers your mortgage payments.
• Income protection insurance, or IP, is a more comprehensive cover, which covers your general financial outgoings. Over a set period of time, such as until you are well enough to return to work, IP insurance will pay out a proportion of your income to cover your outgoings, including your mortgage payments. Consequently, IP is a more expensive cover than MPPI, but it is more comprehensive in terms of your personal finances.

There's no base rate for mortgage protection premiums – they will take into account your age, employment status, mortgage payments and any other product features you choose. A rough guideline is that most policies cost between £15 and £100 a month. Look into the different options and decide what's best for you.

Step 11

What does LTV mean?

LTV stands for ‘loan-to-value’ ratio. The loan-to-value ratio represents how much loan you take out in relation to the value of the property. If the property is worth £100,000 and you have £30,000 to put down as a deposit, you need a mortgage of £70,000 and you have a loan-to-value ratio of 70%. If you were able to put down a deposit of £50,000 for the same property, you would have an LTV of 50%. The lower your LTV, the better overall deal you will be able to get, because a low LTV means that the lender has less to lose if you don’t keep up with your repayments.

There’s a ‘maximum LTV’ on every deal – the maximum amount of money the lender is prepared to let you borrow. The maximum LTV that most lenders will offer is 90%, but for such a high LTV you might incur some higher lending charges (HLCs).

Step 12

What does HLC mean?

‘HLC’ stands for ‘higher lending charge’. If you can’t put down a deposit of 25% of the property’s value, meaning that your LTV ratio is high, your mortgage lender is likely to charge an HLC. The HLC covers the risk that they are taking in taking out a loan with a high loan-to-value ratio. See ‘What does LTV mean?’ for more information.

Step 13

What type of valuations do I need and why?

There are two types of valuation that you should get on the property: a mortgage valuation and a property survey.

• A mortgage valuation is usually carried out by the lender, and is in the lender's interests. The valuation is so that the lender can confirm that the property is sufficiently valuable – in other words, that they agree with the amount of money they will be lending you to buy it. It is not in the lender's interests to lend out money to buy a property that will lose its value, because if a borrower failed to repay their mortgage, the property would be repossessed and sold to cover the debt of the mortgage. This is why the lender will check out the building and confirm that they are happy to lend out the money. A mortgage valuation is generally a superficial examination, lasting about half an hour, and will only check over obvious features and confirm whether you are paying the right amount for the property.
• A property survey is a thorough examination of all of the property's features and defects, both structural and superficial, and it is always in the borrower's interests to have one carried out. The survey aims to uncover any problems that aren't obvious at first glance – in particular, problems that will require money spent to remedy them after the property has been bought. If you're looking to buy an older property, it is essential that you get a structural survey carried out.

In short: the mortgage valuation protects the lender's interests, and the property survey protects the buyer's. All offers to buy properties should be made "subject to survey", so that you can reserve the right to re-negotiate a purchase if the survey flags up anything expensive.