Buying a home is the largest and most important purchase that you will probably ever make. Unless you happen to have a large amount of money secreted away somewhere, you will require a mortgage to help finance your purchase. It is crucial that you choose the right mortgage as it will be a serious commitment that will impact your life for the next two decades and more.
Here’s our beginners’ guide to mortgages, which will help you to make the right decisions.
What is a mortgage?
A mortgage is a loan that you take out to enable you to buy a home. The loan is secured against your property until it is paid off in full and the loan can be paid off over a period of several years. 25 years is the most common term for a mortgage, but you are able to source products with shorter or longer terms.
If you are unable to keep up your repayments, your lender can repossess your property. It is vital that you can afford the monthly repayments and you consider the fact that your circumstances could change.
How do you work out what you can afford to borrow?
You will find mortgage repayment calculators online which will enable you to assess what your repayments will be depending on the term of the mortgage and the interest rate. Mortgage affordability calculators will give you an indication of how much lenders will be prepared to let you borrow. It is important to think about the running costs of the property you wish to buy including utilities, council tax, insurance and routine maintenance. You should never overstretch yourself when deciding how much to borrow.
Lenders will decide how much you can borrow based on your income (basic income, income from investments, financial support from a spouse and child benefit). Any financial commitments you have will also be taken into account. Lenders will require proof of your earnings and expenses.
Since 2014, mortgage lenders have been obliged to examine your ability to repay your loan in future years if interest rates rise or if your circumstances change due to the loss of your job or having a baby, for example.
Where can you get a mortgage?
You can choose to approach a bank or building society directly for your loan. Alternatively, you could use the services of a mortgage broker or independent financial adviser (IFA) who will compare the various available mortgage products. Brokers and advisers may be able to offer you products that are not available via a direct approach to a lender. You should be aware that some brokers will compare all of the available mortgages whilst others only work with a certain number of lenders.
Your broker or IFA may make a charge for their services but must advise you of this from the outset.
If you wish to get a feel for what is available before approaching any institutions, comparison websites are a good place to start. Moneyfacts, Money Saving Expert and Which? are all worth looking at, and you should use more than one website as a source of information to find the best mortgage.
What happens during the mortgage application process?
There was a time when a mortgage application took only a few minutes and lenders made decisions based on minimal information. But since the financial crisis, things have changed. Your lender will conduct detailed affordability checks and will ask you to provide evidence to support the information you have provided about your finances.
Before making your application, order up your credit score reports from the three principle credit check agencies. Check these to ensure that the information is correct because mistakes can be made and could impact your ability to borrow. You should then gather together the documents you will require to support your application.
These could include the following:
- Your utility bills
- Your credit card statements
- Evidence of any other personal expenses
- Proof of any benefits you have received
- A P60 form from your employer
- Your last three months’ payslips
- Passport or driving license
- Bank statements of your current account for the last six months
If you are self-employed you will also need:
- Your accounts for the last three years
- Tax return form SA302 if you have earnings from more than one source
Print outs of online statements and bills may not be accepted. Prepare for your application by obtaining hard copies of your documents in advance of approaching any lenders.
If your application is accepted, the lender will provide you with a ‘binding offer’ and a Mortgage illustration document which explains the terms of your mortgage. You will benefit from a reflection period of at least seven days which you should use to make comparisons to ensure you have secured the best possible deal.
What is a deposit and do you need one?
When buying a property, you will need to pay a deposit. This is a sum of money which covers part of the cost of the property. The larger your deposit the better as a significant deposit will reduce the amount of money that you need to borrow and therefore your monthly repayments.
A large deposit could also secure you a lower interest rate on your loan. This is because the lender is taking less of a risk. A deposit of at least 40% of the purchase price will enable you to benefit from the lowest possible interest rates.
You will need a deposit of at least 5% of the value of the property you wish to buy. Some lenders will insist on an even larger deposit.
What are repayment and interest-only mortgages?
The money that you borrow is referred to as the capital. The lender will charge interest on the capital until it has been repaid. You can choose to pay back the interest only or to repay the interest and the capital.
With an interest-only mortgage your monthly payments cover only the interest on the loan. You will need to establish a means of repaying the capital at the end of the term. This type of mortgage has fallen out of favour with lenders and can be hard to secure as, in the past, these products have resulted in many people being left with enormous debts that they simply cannot repay.
With a repayment mortgage, you pay the interest and a portion of the capital borrowed each month. At the end of the mortgage term you will owe nothing further to the lender and you will own your home outright.
What types of mortgage are available?
Mortgages are available with both fixed and variable interest rates. With a fixed rate mortgage your repayments will remain the same for the specified period of time. This will usually be two to five years. Regardless of what happens to interest rates generally, the rate which is applied to your borrowing will remain the same. After the fixed period has ended you can look for a new deal or return to a variable rate.
Fixed rate mortgages
A fixed rate mortgage gives you greater peace of mind and enables you to budget accurately. However, this type of mortgage may be subject to a less favourable interest rates than a variable rate product, and if interest rates fall, you won’t benefit. There may be charges if you wish to end the agreement early.
Variable rate mortgages
If you choose a variable rate mortgage, the interest rate will go up or down in line with the Bank of England base rate. There are several types of variable rate mortgage which you should acquaint yourself with:
- Standard variable rate (SVR)
This is a mortgage at the normal interest rate that your lender charges. You will be able to overpay or leave at any time.
- Discount mortgage
A discount mortgage features a discount off the standard rate for a specified period of time. This will give you lower repayments initially but there may be penalties if you wish to leave early.
- Tracker mortgage
This is a mortgage which moves directly in line with the Bank of England base rate for a specified period of time. There may be penalties if you wish to switch to another deal during the specified period.
- Capped rate mortgage
With a capped mortgage, the level to which your interest rate can rise is capped at a certain level. Your rate will still fall if the SVR comes down. The interest rate you are offered initially will often be higher than that of an SVR mortgage, but you will enjoy some protection against any steep rises in interest rates which occur in the future.
- Offset mortgage
This a mortgage which is linked to your savings and current account to reduce the outstanding capital that you pay interest on. Your savings essentially become an overpayment to clear the mortgage early.
Before you even start to look at any properties it is best to get your finances in place. Gather together all the documents you will need, think carefully about how much you can really afford to repay each month and explore the available deals. Listen carefully to any advice you are given and don’t forget to factor in any fees and charges associated with apply for a mortgage.