How mortgages work

The mortgage market
A mortgage is essentially just a very large loan. Unlike an ordinary bank loan or overdraft however, a mortgage is ‘secured’ on a property. This means that if you aren’t able to make the necessary repayments, your mortgage lender may have the right to sell your home in order to recover any money they are owed.
That’s the bad news. The good news is that the UK mortgage market is highly competitive. This means mortgage lenders often offer very attractive rates in order to lure in new customers. Often these rates only apply for the first few years of a mortgage and then you’ll revert to a more expensive rate, referred as the standard variable rate. Once this happens, it’s usually worth shopping around for another deal, which is called remortgaging.
In total, there are over 8,000 mortgages on offer here in the UK. Below we look at the main types of mortgages you can get.

Repayment mortgages
Most mortgages in the UK are repaid over 25 years, although you can get a mortgage which lasts for a longer or shorter period if you wish. With a repayment mortgage, you make a payment each month. Part of this payment is used to pay off a little of your mortgage debt, the remainder is used to pay for any interest due that month.
As the months and years go by, the money you owe on your mortgage gets gradually whittled away. Finally, after the 25 years is up, you should have paid off your mortgage in full. At this point your house is yours and yours alone.

Interest-only mortgages
Interest-only mortgages work slightly differently. You make one payment for any interest accrued in that month. Then you also make a second payment that goes into a type of investment fund. The idea here is that after 25 years have passed, your investment fund will have grown to such an extent it pays off your mortgage.
Compared with repayment mortgages, interest-only mortgages are more risky. There is a chance that your investment fund doesn’t grow quickly enough and you’ll have to pay the difference between its value and the amount of mortgage debt you owe. Additionally, if interest rates change, the monthly payments you make will rise and fall by a greater amount than if you had a repayment mortgage.
If you like you can get a mortgage that is part repayment and part interest only. You can also get a mortgage which has one of the following features.

Cashback mortgages
One type of mortgage that particularly appeals to first-time buyers is a cashback mortgage. As the name implies, you receive a cash lump sum from the lender. In return for this, you have to pay the lender’s standard variable rate for a set period of time. Although these deals sound attractive, you may find the cashback is not enough to compensate for the extra interest you end up paying compared to other deals offered to new customers.
The last few years have seen some more complex types of mortgages being made available. These are best suited to those people who are disciplined about their finances.

Flexible mortgages
A flexible mortgage allows you to make overpayments and underpayments on your mortgage, and even take a payment holiday. Making overpayments can save you significant amounts of money, as you’ll end up paying less interest and pay off your mortgage sooner.

Offset mortgages
An offset mortgage allows you to bundle debts and savings products together, with the aim that you pay less interest overall. Mostly they are used by people who wish to offset their savings accounts against their mortgage, and they then pay interest on the net amount. This can work to your benefit, as mortgage rates are typically higher than savings rates and you also don’t have to pay any tax on any mortgage interest you save, as you would do on a normal savings account.

Current account mortgages
Current account mortgages take the offset principle a step further. Here your current account and mortgage are merged into a single account – effectively turning your mortgage into one huge overdraft. The attraction here is that the moment your salary hits your current account, you’re paying less interest on your mortgage.
Flexible, offset and current account mortgages can save some people significant amounts of money but they often charge a slightly higher rate of interest than more straightforward mortgage deals.

Mortgage interest rates

Why interest rates change
Mortgage interest rates are closely linked to the base rate. This is set at the start of each month by the Bank of England’s Monetary Policy Committee and they move it up and down with the aim of keeping inflation at a low and constant rate.
Mortgage lenders’ standard variable rates are typically between one and two percentage points higher than the base rate. So, for example, if the base rate was 5%, most standard variable rates would be between 6% and 7%. If the base rate increases, your mortgage rate is likely to increase as well, and by roughly the same amount.
Mortgage lenders make special offers to new customers, and these typically last for between two and five years. Most lenders will charge you a redemption penalty if you want to move your mortgage before the special offer expires so check these out before choosing a deal. A few mortgages charge redemption penalties after the special offer period has expired, but these deals are rarely competitive and are best avoided.

Fixed rate mortgages
Fixed rate mortgages are ideal for those who are on a tight budget or are worried that interest rates might increase significantly. As the name implies, the amount you pay each month is fixed for set period of time, usually between two and five years. Historically, fixed rates have been the most popular option among homebuyers.

Discounted rate mortgages
A discounted rate is a set discount, say 1%, compared with the mortgage lender’s standard variable rate. So if the base rate moves, your discount rate is likely to move as well.

Tracker rate mortgages
Although mortgage rates tend to move when the base rate does, there is no exact link between the two. In fact, many people believe that mortgage companies are very quick to pass on interest rate rises and slow when it comes to falls, sometimes even not passing on the full amount of any cut.
This has led to the invention of the tracker mortgage. These are variable-rate mortgages but ones which have an explicit link to the base rate. For example, a tracker mortgage could offer the base rate plus one per cent.

Capped rate mortgages
Capped mortgages are relatively rare. Essentially they are variable mortgages but with a guarantee that the interest rate will never rise above a set level. They tend to be quite expensive relative to other types of mortgage.

Getting a mortgage quote

Start off on the right foot
Before you start looking at houses and putting in offers it’s worth doing some initial work on finding a mortgage. You can get what’s known as a decision in principle from a lender that they will lend you a certain amount and this will demonstrate to sellers and estate agents that you’re a serious buyer and will be able to move forward quickly.

Getting mortgage advice
You’ll also need to decide whether you want to get advice on choosing a mortgage. Mortgage brokers can scour the market on your behalf and recommend you the best deal for your situation. Most mortgage brokers will charge you a fee for their services, although there are some fee-free mortgage brokers around. Sometimes they have access to special deals that are not available direct from a mortgage lender.
If you go a bank or building society they will also be able to provide you with some advice on which mortgage to take out. However, they will only be able to advise you on deals within their product range, so you may not get the best deal possible.
Regardless of whether you choose to take advice or not, when you receive a mortgage offer your broker or lender will provide you with a Key Facts Illustration which sets out all the key information relating to your home loan. It’s worth reviewing this in detail and paying particular attention to what will happen to your monthly payments after any special offer you get expires and what fees and commission are payable and to whom.

Mortgage deposits and other costs
In most cases, you’ll be asked to put down a deposit to pay for part of the cost of your house. Generally speaking, the smaller the deposit you put down, the higher the rate of interest you’ll be charged. If you put down a small deposit, you may also get hit with an additional fee known as a higher lending charge.
A typical deposit is 10% of the price of a property but it is possible to put down smaller amounts. If you put down a deposit of just 5%, the number of deals available becomes quite limited. It is possible to put down no deposit at all, but these mortgages tend to be very expensive and carry a much greater risk of negative equity (this is where the value of your home is less than your mortgage, making it hard to move to another property).
There are other costs to consider too. You’ll have to pay for stamp duty, legal fees, valuation, surveys and removal costs. All these need to be factored into your home buying budget.

Salary multiples
Traditionally mortgage lenders have offered people three times their salary. So someone earning £30,000 could get a mortgage of £90,000. If you’re buying with a partner then you might be offered two and half times your joint income. Overtime, commissions and bonus payments may be included in the calculations too, although they won’t be given as much weight as a salary as their payment is not guaranteed.
More recently, mortgage companies have started to offer higher multiples and four or four and half times salary is now quite common. Indeed, it’s possible to get even higher multiples if your job is one where a significant increase in salary can reasonably be expected in the next few years.

Affordability
As house prices have risen ever higher, lenders have started to look at more sophisticated ways of assessing how much money they will lend people. They may look at affordability, and study your income and expenses to see how big a mortgage you can comfortably manage.
They will look at any other debt commitments you have, such as credit cards or car loans. Lenders should also consider if you’ll be able to afford any increase in the cost of your mortgage when any initial offer expires, e.g. a fixed or discounted rate.

Self-certified mortgages
If you’re self employed it can be hard to prove what your typical level of income will be. This is where self-certified mortgages can help. With these home loans, you don’t have to prove your income, but it’s vital to ensure that you’ll be able to afford the repayments on any mortgage you’re offered.

Credit checking
If you want to get a decision in principle or formally apply for a mortgage, a lender will check your credit record before deciding whether to go ahead. Depending on the health of your credit history, a lender many offer you a higher rate than advertised or even decline your application altogether.
If you’re not happy with the offer you receive, you can try another lender. They all use different criteria to decide who to lend to, so a rejection from one lender does not mean you won’t be able to get a mortgage from another. Each application leaves a record on your credit report however.

Insurance and your mortgage
Your mortgage lender will probably be very keen to sell you insurance alongside a mortgage. Some lenders will insist that you take out mortgage life cover which pays off your mortgage should you die. They will want to sell you building and contents insurance as well. They may offer mortgage payment protection insurance too, which is designed to pay off your mortgage debt should you fall ill or become unemployed.
Be warned though, as buying any of these types of insurance direct from a lender can mean you paying much more than you need to. Instead, search for a better deal online and you’ll probably find a comparable protection for a fraction of the price. You may also find it’s worthwhile to look for a general income protection plan, rather than one that’s only designed to cover just your mortgage payments.

Bad credit mortgages

Can you get a mortgage with bad credit?
So, you’ve got a bad credit record. Perhaps you’ve missed a few credit card payments, have had a County Court Judgment awarded against you or have previously been made bankrupt. Does this mean you can’t get a mortgage?
Years ago, the answer probably would have been ‘yes’. These days though, lenders are much more prepared to lend to people with a less than perfect financial history. The technical (and slightly unflattering) term for this type of mortgage is sub prime. They are also known as bad credit or adverse credit mortgages.

Try a mortgage broker
You’ll need to approach a mortgage broker to get a bad credit mortgage and they will search the market on your behalf. Increased interest in this type of mortgage has resulted in most lenders offering bad credit mortgages as part of their service these days.

What sort of deals can you get?
As you might expect, the interest rate you’ll be charged for a bad credit mortgage will be slightly higher than for an ordinary mortgage, and exactly how high will depend on how bad your credit history is. Arrangement fees and redemption charges tend to be higher than for a normal mortgage too.
Although increased competition has resulted in better rates becoming available, there is still a big difference between the best and the worst deals on the market.
Like ordinary mortgage deals, you should be able to get a fixed-rate bad credit mortgage in order to protect yourself from interest rate rises. Other types of interest rate such as discounts and trackers are also available.
Even better news is that once you’ve had a bad credit mortgage for about three years, and not missed any repayments, you should have repaired your credit record to such an extent that you’ll then qualify for a cheaper mortgage deal from a standard lender.

First-time buyer mortgages

Getting on the housing ladder
It’s hard to get on the housing ladder these days. House prices have soared over the last decade making many properties unaffordable for first-time buyers, particularly in London and the South East.
There are various ways first-time buyers can get additional help however. We run through the main areas to look at below.

Help from parents
First-time buyers are increasingly getting help from their parents in order to get on the housing ladder. There are various ways to do this, assuming your parents agree of course!
The simplest way is for parents to contribute towards a deposit. In some case, parents have even remortgaged their own property in order to find the money to do this. It’s also possible for parents to be a guarantor for your mortgage, meaning they would be liable to make the payments if you weren’t able to do so.

Buy with friends
Many first-time buyers are teaming up to buy a property together. While this can mean a bigger budget, it’s important to think about what happens should your circumstances change and one or more people want to move out. You may want to have a contract drawn up by a lawyer to cover what happens in these circumstances.

First-time buyer mortgages
Many mortgage companies offer special deals to first-time buyers or recent graduates. Sometimes they will offer to pay for legal fees and valuations and even waive their normal arrangement fees. Graduate mortgages typically allow you to borrow more money in return for a guarantee from your parents that they cover part of your mortgage payments if necessary.

Government schemes
The government offers a range of schemes to help first-time buyers. These include the Key Worker Living Programme, which assists those in the certain areas of the public sector such as teachers and nurses. There is also the Homebuy scheme which allows you to buy a property in conjunction with a housing association.

Longer and longer mortgages
A final option is to look to pay back your mortgage over longer than the usual 25 year period. This has the impact of lowering your initial payments but will result in you paying a lot more interest in the long run.

Buy-to-let mortgages

The rise of buy-to-let
With house prices soaring, buying additional properties to rent out has become increasingly popular. In order to fund these deals, most people take out a buy-to-let mortgage. The basic idea is that the rental income should cover the cost of the mortgage and any maintenance costs, so that the buy-to-let investor will make the majority of their profit from any increase in house prices.
In most respects, taking out a buy-to-let mortgage is just like taking a mortgage on your main home. Most lenders offer buy-to-let mortgages and interest rates have become increasingly competitive in recent years and are now almost as cheap as those offered on ordinary mortgages. You can even remortgage a buy-to-let property to take advantage of special offers given to new customers.
There are some key differences however, as we describe below.

Interest-only deals
Most buy-to-let mortgages are interest-only mortgages rather than repayment ones. This is because buy-to-let mortgages are usually paid off using the sale proceeds of the property in question.

Deposits
A larger deposit is also required than with an ordinary mortgage. Typically, a deposit of 20% of the purchase price is required although some buy-to-let lenders are now accepting smaller amounts.

Rental cover
With an ordinary mortgage, your mortgage lender will assess your salary to see if you can afford the home you want. With a buy-to-let mortgage, the likely rental value will be assessed to see if it covers the necessary mortgage payments. Usually, a lender will insist that the rental income covers at least 125% of the mortgage costs.

Tax
Tax is something you need to consider with regards to buy-to-let. Rental income is taxable, although you may be able to offset mortgage interest costs, agents’ fees and other expenses. You may also be subject to capital gains tax on any profit you make when you come to sell a buy-to-let property.

Remortgaging

New customers only!
As mortgage lenders offer their best deals for new customers, remortgaging has become common place in the UK. The savings can be substantial, especially if you’ve got a large mortgage or are no longer enjoying any special introductory offer.

Will you pay a penalty?
The first step in remortgaging is to check to see what it will cost you to change lenders. If you’re on a fixed-rate deal for example, you’ll probably have to pay a charge which could amount to a few months’ interest. This could negate any savings you make by switching to a cheaper mortgage.
Mortgage companies also charge a standard fee for closing down a mortgage. These have been the subject of an investigation by the Financial Services Authority, due to significant increases in the amount being charged in recent years. The good news is that mortgage lenders have backed down with many of them reducing the amounts they charge.
If you’re unsure how to calculate any redemption penalty on your mortgage, then a quick call to your mortgage lender will be required and they should be able to give you the information relatively quickly.

Search around for a cheaper deal
The second step in the remortgage process is to hunt around for a cheaper deal elsewhere. Mortgage companies are always looking to attract new customers so finding a cheaper rate shouldn’t be difficult. Most companies will offer slightly different deals for remortgages and for house movers.
Be aware that if you do switch mortgage lenders, you might have to pay for legal fees and a valuation. Some companies will offer to refund this money, if you do end up switching to them. You need to watch out for arrangement fees too – many of the cheapest deals carry fees of over £1,000, which makes them less attractive to those who have smaller mortgages.

Try your current mortgage lender
Having found a better deal, it’s time to go back to your current lender. Usually, they will want to keep your business and may make you an offer, such as switching you to one of their own cheapest deals.
This can often be the best way to go, as it means less paperwork for you and also avoids the cost of legal fees and a valuation that you’d suffer if you’ve switched mortgage lenders.

Make the switch
Once you got the best offers you can get from both your current lender and from the wider market, it’s time to decide. Weigh up the total cost of switching (redemption penalties, exit fees, legal fees and valuation) against the amount you save each month.
To do this accurately, make sure you’re comparing like with like. So, if you have a repayment mortgage with 20 years left to run for example, you can’t compare the monthly payments for this against the payments for a new mortgage that lasts for 25 years.