What is a Mortgage?
As most people don’t have the money to buy a home outright, banks and other lenders offer a loan known as a “mortgage” to help people pay off their homes over a longer period of time – typically around 25 years.
The term “mortgage” specifically refers to a loan that is used to purchase a property, where the property is then used as security against the mortgage. This means that if you fail to keep up with your repayments, your lender may repossess your home in order to recover the loan amount.
In order to get a mortgage in the first place, most lenders will require you to put down a minimum amount of 5% of the property value, which is known as a “deposit”, with the lender providing a mortgage for the remaining 95%.
It is important to distinguish between property value and purchase price, as the lender will only provide a mortgage against the property value. So if the purchase price ends up being higher than the property value, your deposit will need to cover the additional amount.
A property is valued at £100,000, and you’ve agreed to buy it for £110,000, using a 95% mortgage.
The mortgage will only cover 95% of the property value (of £100,000), which means it will only cover £95,000. This means that your deposit amount will need to cover the remainder of the purchase price, which is £15,000.
Loan to Value (LTV)
Loan to value refers to the loan amount relative to the property value. So if the property is valued at £100,000 and you require a mortgage of £75,000 to complete the purchase, your LTV would be 75,000/100,000 = 0.75 or 75%.
Typically, the lower your LTV the more favourable the interest rates that you’ll have access to.
In addition to a deposit, lenders will also look at your income and your credit rating when determining how much you are able to borrow and what interest rates you will be eligible for.
When it comes to repayments, there are three mortgage options to choose from; repayment mortgages, interest-only mortgages and part-and-part mortgages.
This is the most common type of mortgage, where you pay off the interest and repay a portion of the capital (the amount you have borrowed) on a monthly basis. At the end of the term, typically 25 years, your mortgage should be paid off and you’ll own your home.
With an interest-only mortgage, you’re only paying the interest on the loan and nothing off the capital (the amount you have borrowed). This type of mortgage makes for significantly lower monthly repayments, but is quite uncommon these days as lenders require that you have a plan in place to pay off the rest of the loan at the end of the term.
A part-and-part mortgage is a combination of a repayment mortgage and an interest-only mortgage. Much like an interest-only mortgage, you’ll need to have a plan in place to pay off the rest of the loan at the end of the term.
Many people choose to buy a home together using a joint mortgage. Although this is usually couples, we also see friends or family buying together. There are some major benefits to buying with someone else, but also some challenges to be aware of.
One of the major benefits of having a joint mortgage is that you can pool your resources and afford a more expensive property. The lender will look at the income of all the people involved; sometimes they allow you to borrow three times the primary earner’s income plus half of the other earner’s, other times lenders add income together and multiply by up to 3.5 times. Whatever method is used, buying jointly typically means you’ll be able to borrow quite a bit more.
Applying for a joint mortgage may also help when it comes to getting approved, should you have any blemishes on your credit record. When you apply for a mortgage on your own, the bank is looking only at your credit score and credit history. When you apply for a joint mortgage, however, the lender will evaluate both credit histories together. If one of you has a low credit score, it can be made up for with a high credit score from whoever you’re buying with. This can also be a disadvantage, however, as a partner or friend’s credit history may negatively influence the amount you can borrow and the rate at which you do so.
Joint tenancy or tenants in common
If you do decide to buy with more than one person, sharing the property purchase as a couple or with friends and family, there are two ways of owning the property:
Tenants-in-common means that you and your friends each have separate shares in the property: you’ll need to work out between you how much each share is. Each person involved has separate and distinct shares of the joint mortgage. If something happens to anyone who has a share in the property, what happens to their share is determined by an appointed trustee (usually one of the other tenants).
Joint Tenants all have equal rights to the property. Should something happen to one of the joint tenants, their share goes to the remaining tenants. Normally the sole survivor of two Joint Tenants can sell the property and only needs a death certificate to prove their title or ownership. This is a very common and convenient form of ownership between husband and wife or partners who live together, where each person is happy for the survivor to be the absolute owner.
Buying with friends or family means that instead of you, or you and your partner getting a mortgage, you have several people on the deeds, which can ease the financial burden.
Lenders that allow friends to buy together usually allow a maximum of four people, but this can vary. Not only will different lenders allow different numbers of people to buy together, but the amount you can borrow varies as well. Some may only consider the two highest incomes, whereas others may take all four into account.
In addition to working out whether to take out a repayment mortgage or an interest-only mortgage, there are a number of interest rate options to choose from. With each mortgage type having its own pros and cons, professional mortgage advice is highly recommended to ensure the best option for your needs.
Fixed rate mortgages
With a fixed rate, the interest you’re charged and your mortgage repayments will stay the same throughout the length of the deal no matter what happens to interest rates. These mortgages are often referred to as ‘two-year fixed’ or ‘five-year fixed rate’, depending on how long the rate is fixed for.
On the plus side, you know exactly where you are with a fixed rate, helping you budget your monthly spend. On the downside, 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 advantages of a variable rate is that you can usually overpay or leave at any time, and your interest rate may decrease, meaning that you pay less. However, interest rates can also go up at any time, and you may end up paying more.
Standard variable rate (SVR) mortgages
A standard variable rate is the lender’s standard interest rate, which is chosen by the lender, and typically follows any rise or fall in the base rate set by the Bank of England. This type of mortgage will last as long as your full mortgage term, unless you decide to take out another mortgage deal.
Tracker mortgages shadow another interest rate, normally the Bank of England’s base rate plus a few percentage points. If, for example, 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 are tracking increases, so too will the amount you pay each month. 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.
This 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 have lower payments at the start of your mortgage when many people want to keep monthly repayments lower. And if the lender decides to cut their SVR, your mortgage payments will go down too. Of course, the lender could also decide to increase their SVR, in which case your payments go up.
Capped rate mortgages
Capped rate mortgage are a bit like tracker mortgages, in that your rate moves in line with the lender’s SVR. The cap, however, 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. Of course, payments could rise too, but you can be certain of the maximum amount you may have to pay because of the cap.
These mortgages work by using any money you have in designated savings or current accounts 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 £25,000, you will only be paying interest on £225,000.
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