What is a Mortgage?
Written by Martha Lott
10th Jul 2019 (Last updated on 31st Mar 2020) 8 minute read
A mortgage is a loan borrowed from the bank, building society or a mortgage broker that you use to purchase property. You'll pay back your mortgage each month over the course of between 25-35 years, with added interest depending on which type of mortgage you choose.
Your mortgage will be secured against the value of your property until the whole sum of the loan is paid off. If you're unable to keep up with repayments, your mortgage provider may repossess the property to make their money back. This is the worst case scenario, however.
A conveyancing solicitor will liaise with your mortgage provider to help with the legal aspects of buying a house. We’ve compiled this guide on everything you need to know about mortgages, from the different types of mortgage to how to apply for one.
How Does a Mortgage Work
A mortgage works like any other loan, it allows you to pay the money back over a long period of time with added interest. A typical term for a mortgage repayment is 25 years. However, the likes of 35-40-year mortgages have increased, especially amongst first-time buyers with the ever-rising house prices.
You'll pay interest on your mortgage loan, with how much you pay depending on the base rate and which type of mortgage deal you go with. Interest rates can vary monthly, but a fixed-rate mortgage will mean the amount you pay monthly will remain the same, ideal for those looking to budget or applying for a mortgage on a zero-hour contract. You should ensure you can afford a mortgage.
When looking for a mortgage, you should aim to lower the loan to value (LTV) as much as possible as the amount of mortgage you’ll be eligible for will depend on how much of a deposit you pay. The larger your deposit, the more mortgage deals will be available to you.
An LTV indicates the deposit size in proportion to the entire value of the property you wish to purchase. For example, if your deposit is £20,000 for a property valued at £100,000, this would give you an LTV of 80%. Most providers offer mortgages with a 95% LTV, although the deals offered may not be the best available.
The lowest LTV mortgages usually start at 60% which will offer the best deals, and can range all the way to 100%, although 100% LTV mortgages are rare. Most common LTV mortgages are usually 85-95%.
How to Apply for a Mortgage
You can either apply for a mortgage directly from the bank or building society, or you could use a mortgage broker or independent financial adviser. You should begin the application for a mortgage even before you start looking for a house to avoid delaying the conveyancing process.
Mortgage from Bank or Building Society
All banks in the UK have a number of mortgage products available as exclusive direct deals. Many banks offer better deals for current account holders, so it's worth checking the products on offer with your bank first before committing to any outside deals.
In some cases, you may find lower interest rates and it's usually very simple to connect your mortgage to your current account to take automatic payments. However, unless you have a low loan to value (LTV), it's unlikely that you will find rates that are any better than those found by a mortgage broker.
Mortgage brokers, or independent financial advisers (IFA), will compare the whole market for the best suited mortgage for you. They will offer impartial advice and provide you with a range of choices, whereas a bank could only offer you their own mortgage deals.
Although this service comes at a cost with many mortgage brokers often charging a fee or taking commission for their service, they could save you a lot of money in the long run. Not only could they save you money, but they do all the hard work by comparing every type of mortgage on the market.
What Do You Need to Get a Mortgage
To prepare for a mortgage interview with a lender, you'll usually you'd need the following:
- Form of ID
- Proof of address
- Employment details
- 3-6 months of bank statements
- Payslips as proof of salary
- Utility bills
What is a Tracker Mortgage
A tracker mortgage will track the base rate of interest offered by the Bank of England at that specific time, meaning your monthly payments will fall or rise accordingly. A tracker mortgage may seem ideal with your monthly repayment decreasing with the fall of the base rate, but each month will leave you feeling uncertain on how much you have to pay.
If you're not comfortable knowing you can't keep up with your monthly repayments if the interest was to go up, then a tracker mortgage isn't for you. A fixed-rate mortgage may give you more peace of mind. Tracker mortgages usually last between 2-5 years, then the interest on your mortgage will follow the lender's standard variable rate.
What is a Fixed Rate Mortgage
A fixed rate mortgage means that you'll pay the same amount of interest each month as the lender won't raise their rate for a set time. This is the most popular mortgage type as there are more fixed-rate mortgages available.
Whilst a fixed rate mortgage means the amount of interest that you'll you pay won’t increase, it also means it won't go down when the base rate decreases. This could leave you paying more than you would with another mortgage deal. A fixed rate mortgage is more suited to those who want reassurance that they will be paying the same amount each month.
What is a Standard Variable Rate Mortgage
With a standard variable rate mortgage (SVR), the amount you pay monthly will vary and will depend on your mortgage lender's decision. Whilst SVR mortgages can often look to the Bank of England for a base rate, the lender can choose to raise or decrease the rate whenever they want.
You'll usually be put on a standard variable rate mortgage by your lender once your fixed rate or tracker mortgage period comes to an end. SVR mortgages usually range from 2-5% above the base rate.
What is an Offset Mortgage
Having your mortgage offset is something you can add to either fixed or variable rate mortgages. It works by linking your savings or current account to your mortgage. You still pay monthly installments, but your savings and current balance act as over payment. This will help to clear your mortgage early.
An offset mortgage helps you to save money throughout the year by decreasing the interest rate that you'll pay. It'll also help you to decrease your monthly mortgage repayments.
What is a Lifetime Mortgage
A lifetime mortgage is when the mortgage loan is secured against your home, but doesn't have to be repaid until after you die or go into long term care. Usually, you have to be over 55 to take out a lifetime mortgage. A lifetime mortgage might affect what you leave as inheritance. This is because once you're gone, the house will be sold to pay for the accumulated interest from the mortgage.
A lifetime mortgage is a good way to release some equity tied up in your home.
What is a Mortgage in Principle
A mortgage in principle is your lender's word that they would lend you a certain amount, 'in principle', whilst you wait to apply and get approved for a mortgage. A mortgage in principle will help you look more serious as a buyer and will work in your favour when you're making an offer on a house.
It's important to remember that a mortgage in principle isn't a guarantee of how much a lender can offer you. There could be a chance that your application could still be declined. The mortgage in principle will usually last between 60 and 90 days.
The Advantages of a Mortgage
A mortgage is the only way most people can afford to buy a house, with the average house price in UK at £230,292. We’ve compiled a list of the benefits of having a mortgage.
Cost Effective – With a mortgage, many people pay it back over 25-35 years with a small instalment each month. By paying a small amount every month, it's a more a substantial amount of money that’s easily manageable.
You’ll Be a Homeowner – The main advantage of taking out a mortgage will be owning your home at the end of it. If you plan on selling your house after paying off your mortgage, there’s a high chance that its value would have increased.
More Beneficial than Renting – Although renting a house can sometimes be cheaper, with a mortgage, you’re paying money towards owning your home instead of straight to a landlord. It will work out cheaper in the long run to buy over rent.
The Disadvantages of a Mortgage
It goes without saying that taking out a large loan such as a mortgage comes with disadvantages. Here we’ve listed the disadvantages that come with a mortgage.
Interest Rates – With a mortgage comes added interest rates. This means that over the course of the 25-35 years, you will end up paying a lot more than the original price of the house.
Decrease in Property Value – Not only do you end up paying a lot more than the original price, there’s a small chance that your property’s value will have decreased by the time you’ve paid it off.
Debt – A mortgage loan is a substantial amount of money and will be the highest debt most people have to pay in their lifetimes. The added interest on top can make paying it back overwhelming.
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