Mortgages

When choosing a mortgage, you can either shop around the different banks and building societies yourself to see what's on offer or you can go through a mortgage broker who will do the searching for you. Typically, the broker gets a fee from whichever mortgage provider you choose.

Mortgage type

The variety of mortgages on offer may seem bewildering. Don't panic though. They can basically be divided into two types according to how you want to pay them off:

  • Repayment - You pay off the interest and the capital (the amount you borrowed) over the full term of the mortgage.

  • Interest only - They may mean you pay only the monthly interest payments, or it might be linked to an endowment policy, pension or ISA. You pay the interest due on your mortgage every month. The full amount of the loan has to be repaid at the end of the mortgage term. In cases where you invest separately in an insurance (‘endowment’) policy, ISA or personal pension, the money you pay in is invested for the length of the mortgage term and is then used at the end of the term to pay off all or part of the mortgage. As with any investment, there is the risk that the final pay-out may not be as much as the capital you borrowed.

Interest rates

Your next decision is what type of interest rate to have for your mortgage.

  • Variable rate - This is the standard rate offered by mortgage lenders and typically moves in line with the Bank of England's base rate. This unpredictability can make it difficult to plan your finances. Nonetheless variable rate mortgages are still very popular in the UK. Generally, there are no penalties for paying off the mortgage earlier than agreed.
  • Fixed rate - The interest rate is fixed at a specific level for a few years, typically two to five years. This means that you know how much your repayments will be for this period. At the end of the fixed term you will be moved on to another rate, such as the standard variable rate or tracker rate. There may be penalties for moving to a different mortgage provider at the end of the fixed-rate term.
  • Capped rate - This is similar to a fixed rate mortgage except that the mortgage provider guarantees that the interest rate of your mortgage won't rise beyond a specified limit. When the interest rate falls below this, you pay the standard variable rate. Because of this, capped rates tend to be higher than fixed rates, so a capped mortgage may be more expensive than a variable rate mortgage.
  • Discount rate - The interest rate is set at a few points below the mortgage provider's standard variable rate for a fixed number of years. Your repayments will still move up and down in line with the Bank of England's base rate, but the difference between your rate and the standard variable rate stays the same. However once the period of the discount rate ends, your rate will increase so you need to make sure you can afford these higher mortgage payments.
  • Tracker rate - your interest rate will move up or down by tracking an external rate such as the Bank of England rate or London interbank rate.

Borrowing limits

Different mortgage providers have different criteria for lending money, but in general the amount you can borrow depends on:

  • your income and, if appropriate, your partner’s income

  • your employment status

  • your other financial commitments

  • the size of the deposit you put down

Mortgage providers will typically take into account your complete financial situation when making lending decisions, rather than just your income. Lenders will normally ask for anything up to six pay slips or, if you're self-employed, for three years of accounts to verify your income. They may also ask for bank statements and references, say from a landlord.

Mortgage providers may also take into account your other regular payments, such as loan or hire purchase payments. You can use a Monthly Budget Calculator to work out your monthly outgoings and how much you can afford to pay out on your mortgage each month.

If you put down a large deposit - measured as a percentage of the value of the home - banks and building societies tend to be more willing to agree to a mortgage.

Mortgage terms

The longer you borrow the money for, the more interest you will pay. However, the longer the mortgage term, the lower your repayments each month. Typically, a mortgage term lasts 25 years.

Cost of financing

There may be extra charges connected to your mortgage application:
  • Arrangement fees - Lenders may charge an arrangement fee.
  • Valuer's report - Because your home acts as security for the loan, the lender wants to be sure that the home is worth the sale price so usually insist on a valuation. This is carried out by a surveyor whose services you pay for.
  • Indemnity guarantee fee - Some lenders insist you take out an indemnity guarantee policy, i.e. an insurance policy, in case you can't pay the mortgage or the sale price of the property is not enough to repay the loan. Look out for penalties for repaying a mortgage early or missing a payment. Check whether your mortgage allows you to take repayment holidays, which may be important if you have an unpredictable income. Repayment holidays allow you to take a holiday from repaying the capital. You will still have to pay the interest, although this is usually added to the next capital repayment.

Ownership

When you take out a mortgage for a property, the legal title of the home is given to the lender, although you retain the right to live there. This is because your home acts as security for the loan. It is only when the mortgage has been fully repaid that you get back the legal title to your home.