Finding the Right Mortgage
How much can I borrow?
Even if you already have a mortgage with a lender, they’ll look at your financial picture when you apply to borrow more money. They are obliged to check that you can afford repayments, especially as you are increasing them.
Lenders used to base what you could borrow on a simple formula: take your income then multiple it by up to five and a half times. But this is no longer the case.
Lenders are much more cautious since the financial crisis and are obliged to assess your ability to pay under rules brought in by the Financial Conduct Authority in 2014. This means they don’t just look at what you earn, but at what you pay out each month and how that might change in the future.
There are three key areas that lenders look at when assessing what they can lend you: your income, your outgoings and future possibilities.
|Income||Lenders will look at your basic income plus any overtime or bonuses; pensions; investments; child maintenance or income from an ex-partner.
|Outgoings||You’ll need to think about what you spend on basics like bills (utilities, broadband, phone, insurance); credit card payments; loan repayments; committed costs such as gym membership and childcare; living expenses (groceries, eating out, entertainment, holidays).|
|Future changes||Lenders will stress-test whether you could still afford to pay your mortgage if interest rates increased or you or your partner were no longer working (because you are ill, taking a career break or having a baby, for instance).|
Your First Mortgage advisor will take you through this process step-by-step and let you know exactly what information your lender needs.
Types of mortgages
Repayment or interest only mortgage
No matter the rate or type of mortgage you have, it will always be repayment or interest only. These are terms to describe how you are paying off the mortgage – as you go (repayment) or in one lump sum at the end (interest only).
- Repayment mortgages,
You pay the interest and part of the capital off every month. At the end of the term, typically 25 years, you should manage to have paid it all off and own your own home outright
- Interest-only mortgages
You pay only the interest on the loan and nothing off the capital (the amount you borrowed). As you are only paying off the interest, you need to have a plan in place to pay off the rest of the loan at the end of the mortgage term. This option is rarely recommended, but it can still be considered.
Fixed or variable rate mortgage
After you and your advisor have worked out whether you choose to pay off both capital and interest (repayment) or just the interest (much rarer these days), you can then look at paying a fixed or variable rate mortgage.
- Fixed rate mortgages
With a fixed rate, the interest you’re charged stays the same for several years. The amount you pay will be the same throughout the deal, no matter what happens to interest rates.
These mortgages are often referred to as ‘two-year fixed’ or ‘five-year fixed’, dependent on how long the rate is fixed for. The good thing is, you know exactly where you are with a fixed rate, helping you to budget your monthly spend. On the down side, fixed rates are usually slightly higher than variable ones, and if interest rates fall, you won’t benefit.
- Variable rate mortgages
A variable rate mortgage is just that – variable – with the amount you pay liable to go up or down if the lender changes the interest rate. The advantage of a variable rate is that you can usually overpay or leave at any time, and your interest rate could decrease, meaning you pay less. However, interest rates could also go up at any time, meaning you end up paying more.
Standard variable rate (SVR) mortgage
This is the normal interest rate that a mortgage lender charges homebuyers. It will last as long as your mortgage, or until you take out another mortgage deal. Changes in the interest rate may occur after a rise or fall in the base rate set by the Bank of England, but the lender chooses the rate.
Tracker mortgages shadow another interest rate – this is usually the Bank of England’s base rate plus a few percentage points. For example, if the base rate goes up by 0.5%, your rate will go up by the same amount. Usually, tracker deals have a short lifespan, typically two to five years, though some lenders offer trackers which last for the life of your mortgage, or until you switch to another deal.
If the rate the mortgage is tracking is low, your mortgage payments will also be low. Equally, if the rate your payments is tracking increases, your monthly payments will increase too. Tracker mortgages are a riskier prospect and you may have to pay an early repayment charge if you want to switch before the deal ends.
Pros: If the interest rate is low, so is your mortgage payment.
Cons: You don’t necessarily pay the same amount each month, which means that payments can go up.
This type of mortgage is a discount off the lender’s standard variable rate (SVR). They usually only apply for a limited length of time, typically two or three years. The advantage of a discount mortgage is that you start your mortgage with lower payments, when many people want to keep monthly repayments as low as possible. Also, if the lender decides to cut their SVR, your mortgage payments will go down too. On the other hand, the lender could also decide to increase their SVR, in which case your payments go up.
Pros: Lower payments at the start of your mortgage.
Cons: Limited terms and if lenders increase their SVR, your mortgage payments increase with it.
Capped rate mortgage
Similar to tracker mortgages, your rate moves in line with the lender’s SVR, but the cap means that the rate can’t rise above a certain level. Although the rate is generally higher than other variable or fixed rate mortgages, it will fall if the lender’s SVR comes down, meaning your payments could fall too. Payments could rise too, but you can be certain of the maximum amount you may have to pay because of the cap that’s in place.
Pros: The cap on the rate means you know exactly what your maximum payment could be.
Cons: Rates are generally higher than variable or fixed rate mortgages.
With this type of mortgage, any money you have in savings or current account is used as overpayments against the interest you pay on your mortgage each month.
Your mortgage lender calculates the interest you owe based on the total amount you have borrowed, but with an offset mortgage, this amount is reduced by the amount held in the linked accounts.
So, if you have borrowed £250,000 and have savings of £35,000, you will only be paying interest on £225,000.
Pros: You could end up paying a lot less interest on your mortgage.
Cons: You must keep a minimum amount in your linked account.
If you buy a house to rent out, you can’t take out a standard residential loan. While a buy-to-let mortgage is similar in many ways, there are some important differences to keep in mind.
You’ll generally have to put down a bigger deposit (usually a minimum of 25%) and interest rates are higher. Lenders work out how much you can borrow based on expected rental income rather than your personal income, with most lenders expecting a rental income equal to 125% of your annual mortgage payments.
Most banks and building societies will insist on a minimum age and income and have stricter eligibility criteria, reflecting the greater risk of buy-to-let loans. Statistics show that borrowers are more likely to default on a buy-to-let than a residential mortgage.
Pros: Buy-to-let mortgages allow you to rent out your property. You could profit from the rent you charge.
Cons: Rates for buy-to-let mortgages tend to be higher as the risk of lending is greater.
For more information and advice on renting out a property, see Becoming a landlord.
Capital raising mortgage
Many people remortgage their homes to release funds for everything from house renovations and holidays to new cars and consolidating debts. In some cases, the rates to repay a mortgage are less than those to repay a loan, so consolidating loans and paying them off as part of your mortgage makes sense. You end up paying more on your mortgage over a greater amount of time but avoid paying high interest rates on loans.
Pros: You could end up paying a lot less interest on your debts by consolidating and paying them off as part of your mortgage.
Cons: You add to the length of time you need to pay your mortgage.
For more information and advice on borrowing money through a mortgage, see Taking out a loan.
Student or graduate mortgage
Banks and building societies now offer students the chance to buy rather than rent. Students can apply for mortgages up to 90% of the value of the property, as long as they have a guarantor to back them up (usually a parent or grandparent).
Schemes like Buy for Uni offer people who are over 18 and in full-time education the chance to buy a home, paying the mortgage by renting out rooms (or using a guarantor to make up any shortfall). Similarly, graduate mortgages offer low deposit schemes, accounting for the debt that may have been built by students.
Pros: Allows you to get on the property ladder as a student and invest rather than spend money on rent. As the property is in the student’s name, guarantors do not pay additional stamp duty.
Cons: Interest rates tend to be higher and you need to have a guarantor who owns property to qualify.
Part and part mortgage
These mortgages combine both interest-only and repayment portions of a mortgage. You can decide what proportion of each to pay, for example, 80% repayment and 20% interest only.
Pros: You can keep your payments relatively low as you pay a proportion of interest-only. You are still paying off some of the capital, which leaves you less to pay at the end of the term.
Cons: The interest rate will be slightly higher than more straightforward mortgage packages.
Poor / bad credit mortgage
You may be worried if you have had CCJs, bankruptcy, arrears or defaults in the past when applying for a mortgage. However, bad credit mortgages may still be available. First Mortgage advisors can find the best package for your circumstances, even with a complex financial history.
Most lenders take into account evidence of a poor credit history. This means that some will not be prepared to offer you a mortgage if you have a bad credit record. However, there are specialist lenders who will consider lending to you, even if you have examples of arrears, defaults or even bankruptcy in your past. You may have to pay a slightly higher rate than someone with good credit history, as the lender will see it as a larger risk to lend the money.
Pros: Allows you access to a mortgage even if you have a bad credit history.
Cons: Higher interest on payments as you are seen as a greater risk.
Green additional mortgages
Green, or ‘energy efficient’ mortgages, let you borrow more money to pay for energy efficient upgrades to your home or to a property that you plan to buy. The result is an environmentally-friendly living space that is more efficient, using fewer resources for heating and cooling and running at a much lower cost.
Energy efficient mortgages are not second mortgages. They are additional borrowing created separately from your main mortgage account. However, the payments are rolled into one, so you make a single payment each month.
Lenders will generally expect you to spend the additional money on energy efficient boilers, insulation or solar panels: anything that leaves a lower carbon footprint and reduces household bills. As you will inevitably save money on utility bills, this is often taken into account when looking at affordability criteria.
Some lenders include ‘environmental payback’ in a green mortgage deal, donating money towards an environmental charity or pledging to plant trees as a way of offsetting the energy used to build and run a house. Most major banks and building societies now offer some form of green mortgage or additional advances. The Ecology Building Society goes one step further with a portfolio that specifically supports the promotion of ecological building practices and sustainable communities.
Making payments on your mortgage
There are three parts to a mortgage:
- Deposit – which is the chunk of money you pay towards buying your property.
- Capital – the amount you’ve borrowed
- Interest –the money charged to borrow the capital
When talking about mortgages, you might hear people mentioning ‘Loan to Value’ (LTV). Put simply, this is the amount of your home that you own outright, compared to the amount that is secured against a mortgage.
For example, if you pay a £30,000 deposit on a £300,000 property, your LTV is 90% (as the deposit is 10% of the value of the property – your mortgage is secured against the 90% portion). Lenders are likely to offer you lower interest rates if you have a lower LTV, as they are taking a less of a risk with a smaller loan.
You pay off the capital and interest monthly over 25 or 30 years with most mortgages, which is why they’re called repayment mortgages. Less common is to pay interest-only, where you pay the interest off monthly throughout the mortgage term, then pay back the original loan as a lump sum at the end. You’ll need to have another way of saving money to pay back the loan at the end. Interest-only mortgages might mean lower monthly payments, but it is a much riskier option.