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 brokers who will do the searching for you. Typically, they get 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 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 - This is also known as endowment, pension or ISA mortgage. 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. To do this, you invest separately either in an insurance policy, ISA or personal pension. The money you pay into the policy/ISA/pension is invested for the length of the mortgage term. 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 rates. Your repayments increase if the interest rate rises, and drop if rates are lowered. This unpredictability can make it difficult to plan your finances. Nonetheless variable rate mortgages are still the most 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. The rate then returns to the standard variable rate at the end of the fixed term. Because the fixed rate is an introductory offer, there may be penalties for moving to a different mortgage provider.
- 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.
Borrowing limits
Different mortgage providers have different criteria for lending money, but in general the amount you can borrow depends on:
- your income
- your employment status
- your other financial commitments
- the size of the deposit you put down
Mortgage providers will typically lend you three to three and a half times your income. A couple can usually borrow either:
- three times the income of the main earner plus one times the income of the second earner, or
- two and a half times the couple's joint salary
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 - Some lenders may charge arrangement fees in the range of £300 although many now waive these.
- 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. Holiday repayments 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.