A mortgage is a loan, but with a property used as security. A bank or building society lends you the money to buy a home, and you agree to make regular payments to pay back the money you have borrowed, plus interest.
If you cannot keep up your repayments, the lender may repossess your property and sell it to clear the debt.
The typical loan period is 25 years, but as property has become more expensive people are borrowing for longer to give them more time to clear the debt; some mortgages now run for 30 or 35 years. You can also have a shorter period, useful if you are nearing retirement. You can work out what period you can afford by using an online mortgage calculator.
Unless you are a cash buyer, you will almost certainly need a mortgage to get on the property ladder. There are thousands of mortgage deals aimed at new borrowers or remortgage deals for existing ones who want to switch from their existing home loan, offered by dozens of lenders, so take time to find the right one for you. You could use an independent broker or do your own mortgage comparison online.
The first thing people many look at when comparing mortgage deals and remortgage deals is the headline interest rate. This shows how competitive the lender is and helps you answer this key question: how much mortgage can I afford?
Mortgage deals come with a range of charges, including property valuation fees, legal fees and arrangement fees. Sometimes a mortgage with a higher interest rate can be cheaper than one with a lower rate, once you have taken all the charges into account. Again, a mortgage calculator can help you do your sums.
Mortgage rates plunged after the financial crisis. In July 2007, the average rate for a two-year fixed-rate mortgage provider charged 7.08%, according to Moneyfacts. By December 2018, it had fallen to just 2.51%. On a £100,000 loan you would have paid interest of £7,080 a year in 2007, but just £2,510 in 2018, an incredible £4,570 a year difference.
Cheap borrowing cannot last forever, so do not take on more debt than you could afford to repay if rates started climbing. Every time mortgage rates rise by 0.25%, it adds around £13 to the monthly interest on a £100,000 loan, or £156 a year. The Bank of England base rate is currently just 0.75%, but it can be far higher; in the summer of 1990, base rates hit an incredible 15%!
To appreciate what a difference the interest rate on a mortgage makes, check out the table below. The monthly payments are shown on a £165,000 fixed-rate mortgage to pay a £220,000 property, paying the interest and capital over a 25-year term (excluding fees). Or do your own mortgage comparison.
Mortgage lenders charge interest in two ways: a variable rate that goes up and down in line with wider borrowing costs, and a fixed rate that is guaranteed for a set term, typically two, three, five or 10 years.
Fixed mortgage rates can be slightly higher but give you the security of knowing exactly how much you will pay every month for a set period. They are particularly attractive if you are on a tight budget and would struggle if interest rates rose.
Currently, the large majority of new borrowers take out fixed-rate mortgage deals on the assumption that rates cannot fall any further but might rise a lot higher.
Two-year fixed rates are the most popular. Many borrowers are reluctant to fix rates for longer periods of five or 10 years, because there is usually a penalty to pay if you want to switch mortgage deals or move home during that period.
While fixed-rate mortgages offer certainty, variable rates give you greater flexibility. Variable rates also tend to be slightly lower, although that could quickly change if interest rates started to rise rapidly.
If taking out a new mortgage, you can look for something called a discounted variable rate. This offers a reduced interest rate for an introductory period – typically two years, but sometimes three or even five years. Again, there may be penalties if you decide to switch deals in that time.
Every bank and building society has a standard variable rate (SVR), which is the interest rate that mortgage borrowers revert to when the introductory fixed or discounted variable rate has expired.
SVRs are notably higher than discounted and fixed rates, so it’s usually not a great idea to stay on them for long. Millions do, though, and pay thousands of pounds more interest than they need to as a result. Inertia exacts a high price.
For most borrowers, it’s ideal to start looking for the best remortgage deals before their existing loan runs out; that way they can avoid the SVR altogether.
Mortgage lenders want to get their money back at some point, so will check you are a good credit risk and are unlikely to fall behind on your repayments or be unable to pay back the money you have borrowed.
When you apply for a mortgage, banks and building societies will ask detailed questions about your income and outgoings, to see whether you meet their affordability criteria.
They will also check your credit report, which is a personal history of all the credit you have taken out in the last six years, plus details of any county court judgements (CCJs), house repossessions, bankruptcies and individual voluntary arrangements (IVAs).
This data is held by three credit reference agencies – Equifax, Experian and TransUnion – and lenders check it against their own records and lending criteria before deciding what mortgage deal to offer and how much to charge. There is no one universal credit score; the agency supplies the information and lenders will judge that according to their criteria. The lenders make the final decision to lend, not the agencies. That means if one lender rejects you, another may be more positive.
Applicants with previous debt problems may be quoted higher rates of interest, worse repayment terms or be rejected altogether. So it pays to have the cleanest possible credit score.
Contrary to rumour, the agencies do not operate credit blacklists.
If you looking to apply for a mortgage, it might be worth checking your credit profile first. Most credit agencies offer a free 30-day trial, during which time you can check your report, but after that charge a fee (usually around £15 a month). If you’re like me, you probably don’t want to pay a fee, so you can simply cancel before this kicks in.
If you ran into money troubles due to problems beyond your control, such as divorce, illness or redundancy, you can add a ‘notice of correction’ to your report explaining the circumstances, and lenders may consider this when considering your application.
There is plenty you can do to rebuild your credit rating and avoid inflicting further damage on it.
If you are struggling to borrow enough to buy the property of your dreams, the following strategies could help.
Borrow over a longer period – If you borrow £200,000 over a 25-year term at 3%, your monthly capital and interest repayment will be £948. Extend the term to 30 years and your monthly payment falls to £843, some £105 less. If you stretch to 35 years, it would fall to £770. The downside is that you pay more interest in total, because you are borrowing for a longer period – but you can always make overpayments or cut your term if you have more money later.
Build a bigger deposit – If you can put down a larger deposit you will pay less on your mortgage each month, for the simple reason that you are borrowing less money. Another advantage is that you should be able to get a more competitive deal. Lenders will charge more if you need to borrow a 95% of your property’s value compared with, say, 75%. If you are aged between 18 and 39, the Lifetime Isa could help you build a deposit, by giving you a government-funded 25% top-up on annual savings up to £4,000, worth a maximum £1,000 a year.
Seek Help to Buy – The Help to Buy: Equity Loan scheme is another Government-funded scheme designed to help first-time buyers get on the property ladder. You assemble a 5% cash deposit, and the government loans you 20% of the cost of a home worth up to £600,000, interest free for the first five years. You can then get a competitively priced 75% mortgage to make up the rest. Help to Buy is only available on new-build properties.
Shop around – Don’t just stick to your own bank or building society; you can choose a mortgage from across the entire market. Smaller building societies and the new breed of so-called “challenger” banks, start-ups with unfamiliar names that are looking to reduce the dominance of the established players, may offer better deals than you will get on the high street. Remember to factor in all fees before making a decision. A mortgage broker may do the job for you, and many offer a fee-free service.
Don’t overstretch yourself – If you start looking at homes that cost around £200,000, you might find yourself falling in love with something costing £225,000 or £250,000. That’s fine if you can negotiate a discount; but if you pay more than you can really afford, it squeezes the money you have left over for other things such as retirement savings. Many lenders will not let you borrow more than four or five times your salary. If more than 25% of your gross monthly income goes on your home, including mortgage and insurance, you may be pushing your luck.
Get a decision in principle – It’s often worth lining up a mortgage before you go property hunting, to help you answer two key questions: can I get a mortgage, and how much can I afford to pay for a home? Also, if your finance is in place, you will be ready to swoop if you find your ideal home. What you need is something called a decision in principle (DIP) or agreement in principle (AIP), a statement from a lender saying it will grant you a mortgage (subject to certain conditions). This will show the vendor’s estate agent that you are serious, which is handy in case other buyers are hovering. If you have past credit problems, this also gives you the security of knowing you can get a loan. The offer will usually be open for three months, which gives you a bit of time to find the right property.
Buying a home is an exciting milestone, but thanks to the UK housing shortage and high prices people are reaching it later in life. It can be confusing and stressful, but the more you know about mortgages and interest rates, the more you can save. The savings could run to tens of thousands of pounds over the life of your loan. Checking out the current best interest rates and the best mortgage lenders is a great way to start.
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