The ultimate guide to mortgages - everything you need to know
There is not just one type of mortgage that fits all.
There are a number of variables which will affect your individual mortgage, such as the mortgage term in years, the interest rate, the loan to value (LTV), the type of mortgage and whether you are able to pass mortgage “stress tests”.
A Complete Guide to Mortgages in The UK in 2020
This article will guide you through the basics of what you should understand before applying for a mortgage.
At the end of the article, you will find resources for various mortgage schemes such as help to buy.
What you’ll find in this article:
- What is a mortgage?
- How much mortgage can I afford?
- Personal residential mortgage
- How much deposit do I need to buy a house?
- Types of mortgage
- What is the average mortgage interest rate?
- Eligibility for a residential mortgage
- Affordability criteria
- Portfolio landlords
- How to get a mortgage
- Costs and fees
- Other types of mortgage
- Government help schemes
- Indepenent mortgage advisors
What is a Mortgage?
A mortgage is a legal agreement where a bank or building society lends money to an individual or groups of individuals, in order to raise funds to purchase property. The loan will include an agreed interest rate, which is paid back to the lender on a monthly basis.
A mortgage loan will not usually cover the entire cost of the property. As the buyer, you will be required to pay a deposit, also known as “initial money down”, to secure the loan on the property.
The deposit could be anywhere from 5% and upwards of the value of the property and the lender will pay the remaining sum of money. This is known as the loan to value, or LTV, of the mortgage.
For example, if you have a mortgage of £150,000 on a house that’s worth £200,000, you have a loan-to-value of 75% – therefore you have £50,000 as equity.
Why Get a Mortgage?
By obtaining a mortgage, you are able to leverage your current sum of available funds in order to buy yourself a home or to buy investment property.
This means that if you are interested in purchasing a £150,000 property, you’ll only need to contribute a certain percentage of the total value of the property.
If you were able to raise 10% of the property value, i.e. £15,000, then you would need a mortgage of £135,000 (LTV of 90%).
Should I Get a Mortgage?
Securing a loan against a property does not come without risks. You should determine the maximum you can afford in monthly repayments before applying for a mortgage.
You should also note, the higher the LTV of the mortgage (the more you borrow as a loan) and the higher the interest rate, the higher your monthly repayments will be.
How Much Mortgage Can I Afford?
Prepare an accurate budget – write down your monthly incoming and outgoing figures, being careful not to miss anything out. This will provide an estimate of how much money you have left over each month:
Income – outgoings = money left over each month.
You should not spend your entire monthly savings on a mortgage – Set aside a fairly large proportion incase of emergencies etc.
Personal Residential Mortgages
A personal residential mortgage is simply dependent on your income, outgoings and job situation.
Each lender will apply a slightly different criteria to calculate your affordability to apply for a mortgage.
Lenders will now cap your income-to-loan ratio at 4.5 times your income, i.e. the maximum mortgage you can apply for will be 4.5 times your income.
Lenders will also check that you will be able to keep up with monthly repayments if interest rates increased by around 5% or if you or a partner lost your jobs.
How Much Deposit do I Need to Buy a House?
The value of your deposit is dependent on a number of factors: The value of the property and size of the mortgage you are able to secure.
The value of the deposit is the difference between the mortgage and the value of the property. So an 85% mortgage will require a 15% deposit.
As an example, you can calculate your deposit based on the value of the property:
On a property valued at £100,000, a 10% deposit will be £10,000 and a 15% deposit will be £15,000.
On a property valued at £250,000 a 10%deposit will be £25,000 and a 15% deposit will be £37,500.
Types of Mortgages Available in The UK
Mortgages vary according to various factors, including:
- Interest rate
- Term/Payback time
- Interest only or payment
- Fees and charges
So, what are the different types of mortgages available in the UK?
There is an array of different mortgages available, which consist of, but not limited to, the following:
- Repayment mortgage
- Interest only mortgage
- Fixed rate mortgage
- Variable rate mortgage
- Capped rate mortgages
- Buy to let (BTL) mortgages
Repayment mortgages are the most well known type of loan. You will make monthly payments of a percentage of the initial loan + interest. Over the period of the loan, usually 25-30 years, you will have paid back the entire loan, including the interest owed.
Interest Only Mortgages
Interest only mortgage – You are only required to pay the interest owed on the loan each month. You do not pay back the capital. At the end of the term you will still owe all of the original loan. You will either be required to pay the entire loan off, or extend the loan.
Fixed Rate Mortgages
Fixed rate mortgages – The interest rate of the loan is the fixed, therefore fixing the monthly repayments. If the lender increases or decreases their interest rate, you continue to pay the rate that you agreed.
These loans are popular due to the fact that whether the interest rates rise or fall, you will pay the same amount each month.
Variable Rate Mortgages
Variable rate mortgages are the opposite to a fixed rate loan. If interest rates fall, so will your monthly payments, whereas if interest rates rise, so too will your monthly repayments.
Capped Rate Mortgages
Capped rate mortgages have a similar payment structure to variable rates, however there is an upper limit to which your monthly payments are permitted to rise to.
Buy to Let Mortgages
Buy to let mortgages are loans which property investors will obtain. Usually, the LTV will not be as high as the mortgage allowed on your own property of residence.
A BTL mortgage is based on the rental value of the property, i.e. the amount of rent received from letting the property determines the mortgage.
Your personal circumstances are now also taken into account when agreeing a mortgage.
What is The Average Mortgage Interest Rate?
Mortgage interest rates rise or fall from time to time, due to various factors, such as the BOE interest rate.
Interest rates are also different for each type of mortgage, and also on the LTV – a higher LTV will generally attract a higher interest rate.
The current average interest rate for a standard 25-year fixed rate is around 4%. Depending on your situation, this value of 4% could be higher or lower. Your mortgage advisor/broker will discuss the available mortgage rates with you.
Eligibility For a Residential Mortgage
There are various factors which will determine how much money you are loaned and whether you will be successful in obtaining an offer for a mortgage.
Lenders will want to ensure that you are not high risk and that your financial commitments are not too high and you will be able to maintain monthly repayments.
The factors which will affect the loan amount include, but are not limited to:
- Your income – You’ll be asked how much you earn. If you are self employed, you’ll need 2-3 years proof of income.
- Your monthly outgoings and details of where your money is spent.
- Your credit score. A bad credit score will negatively affect your application for a mortgage.
- The loan to value of the mortgage. It is more likely that you will obtain a mortgage for a low LTV.
- The amount of deposit you’re willing to put down.
- Any other debts or loans which you are currently paying.
Affordability Criteria of a Buy-to-Let Mortgage
When applying for a buy-to-let mortgage, your personal finances do play a part in eligibility, however the main contributing factor is the potential rental income of the property.
On average, buy-to-let mortgage lenders require your rental income to be around 25% higher than the monthly mortgage repayment.
There are however now lenders who will require the rental income to be up to 45% higher than the mortgage. This is to ensure you can pay the mortgage if the property is vacant.
It is also common for lenders to “stress test” your BTL property/portfolio – A lender will calculate whether you will be able to keep up with monthly repayments if interest rates were to rise by 5% or even 7%.
Portfolio Landlord Mortgages
A portfolio landlord is a landlord with four or more mortgaged BTL properties.
Mortgages are slightly different for portfolio landlords – usually, lenders will increase their stress test levels, i.e. Your rental income will need to be closer to 145% of the mortgage rather than the common 125%.
The maximum LTV available will also usually be decreased as the portfolio is grown.
How to Get a Mortgage in The UK You could start with asking your current banking provider regarding what mortgages they are able to offer you.
Seeking the advice of a mortgage broker* is often a good choice, especially if your circumstances are not “normal”.
The general steps taken when obtaining a mortgage are as follows:
Ensure you have sufficient withheld funds for a deposit, including any fees and other charges.
Contact a mortgage brokerage or independent mortgage advisor and discuss the property you have in mind for purchasing. They will then provide you with a rough estimate of required deposit and monthly payments.
Re-evaluate your cashflow. Do you have enough money for the deposit? And can you afford the monthly payments from the given options of the broker/advisor?
Contact the seller of the property you wish to purchase and make an offer on the property. The mortgage lender will then send in a valuer to confirm the property is worth the price being asked.
If your offer is accepted, you will then be able to take out the mortgage – you’ll need to contact your mortgage broker/advisor to let them know the offer was successful and that you’d like to take out a mortgage through them.
- As with buying any property, mortgage or no mortgage, you will require a solicitor or licensed conveyancer to complete on the contract(s) of the property.
A UK issued mortgage may or may not cover purchases abroad; You may require a specialist mortgage provider to purchase property in Spain and other countries outside of the UK.
*If you are using an independent mortgage advisor, ensure that they are CeMAP qualified.
Costs And Fees of Mortgages
The largest and most obvious cost of a mortgage will be your initial deposit. This could be anywhere from around £5,000 all the way up to over £500,000 depending on the value of the property and the LTV of the mortgage (loan to value. On average, ranges between 65-80% of the property value).
The second largest cost to you will be the monthly payments of the mortgage.
The monthly payment depends on your type of mortgage, the eligibility factors stated above, the length of the mortgage and your initial deposit.
Other costs and fees which you should consider when taking out a mortgage are:
- Mortgage brokerage fees (Some will be free – they’re paid on commission)
- Product fees / Arrangement fee
- Application fees
- Mortgage survey fees
- Exit fees – if you decide to move to a different lender
Other Mortgage Loans in The Property Sector
Generally, these loans are short term and used by property developers who are near to completion or individuals bidding on a property at auction who will obtain a mortgage within the next few days.
Interest rates on bridging loans are much higher than a traditional mortgage – Interest rates increase by up to 1.5% per month.
West One Loans have a good explanation of the residential bridging loan in their guide to property financing.
A commercial mortgage is similar to a normal residential mortgage apart from the fact the property that the mortgage is secured under is classed as a commercial property.
With a residential mortgage, the lender will look at your personal income/outgoings, whereas with a commercial mortgage the lender will determine the mortgage based on the companies income/outgoings.
Government Mortgage Help Schemes
If you do not have sufficient funds available or are not eligible for a standard mortgage, there are various government schemes available to help you purchase your home or secure a mortgage. These include:
Help to buy – Equity loan – You provide a 5% deposit and the government provides a 20% deposit which is interest free for 5 years.
Help to buy – London – This scheme is similar to above but is specifically for those who wish to get on the property ladder in London. You may be able to obtain up to a 40% deposit from the government.
Armed Forces help to buy – If you are serving or have served in the Armed Forces, the government can provide you an interest free loan.
Starter homes – Only available on new builds, this scheme is for first-time buyers under the age of 40.
Shared ownership mortgage – For non-homeowners who earn £80,000 or under per year.
Social HomeBuy – For people who have lived in social housing for over five years.
Rent to Own – For people living in wales who are currently renting but cannot afford a deposit.
Guarantor mortgage – This is not a mortgage scheme, however, first time buyers are able to use a guarantor to secure a mortgage against their first home. A guarantor, usually a family member, will sign to say they will pay any missed mortgage repayments.
For more information on the above schemes such as which type of properties are eligible for the scheme and how to apply, visit Money Saving Expert’s article on Mortgage Schemes.
Independent Mortgage Advisers
Are you searching for an independent mortgage provider in your area?
If so, Unbiased have a great tool to search specific areas for an independent mortgage adviser near you.
Their tool also allows you to filter results by type of mortgage, value of the mortgage and payment type.
Applying for a mortgage is not a quick process that can be done with a few clicks online.
A mortgage can allow you to leverage your savings in order to purchase your own residential property or step onto the property ladder. You will however have to ensure that you are able to pay the monthly repayments along with passing the lenders mortgage stress tests.
As mentioned in the article, there are various schemes which can aid you if you are a first time buyer or have served in the armed forces and wish to purchase a property.
Mortgages will vary depending on if you are a purchasing a personal residential property or if you are a portfolio landlord.
Mortgage rules and stress tests are also subject to change – we’ll endeavor to update this article if there are any new schemes or rule changes.
If you found this article useful, feel free to share it on your social media so that others can benefit from our guide!
Last updated: April 2020
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