A mortgage lets you borrow the money you need to purchase a property, find out more about applying, and how to get a great deal.
By Laura Rettie, Personal Finance Journalist.
The vast majority of us couldn’t afford to own a home without a mortgage. But understanding how mortgages work, the jargon used when talking about mortgages, and the process of applying for a mortgage is still a mystery for many.
A mortgage is a type of loan, usually from a bank or building society, that is used to purchase property, such as a house or flat.
When you borrow money to pay for a property, the mortgage is secured against the property until it’s repaid. This means that if you don’t keep up with your mortgage repayments, your lender could repossess your home to repay the money you borrowed.
A mortgage is a type of loan, specifically used for the purchase of a property. There are some key differences between mortgages and other types of personal loans. Because a mortgage is secured against the property you’re buying, you can borrow a much larger amount, over a much longer period of time than most other personal loans.
Secured loans, also known as second-charge mortgages, are similar to mortgages because they’re also secured against your property, but are typically taken as a way to release equity from a home you already own.
Other personal loans which aren’t secured against any assets are less commonly used to purchase properties, and in most instances, you wouldn’t be able to borrow enough or over a long enough period to purchase a property with a personal loan.
You may wonder if you can use a personal loan as a deposit for a mortgage, but the majority of lenders won’t approve a loan to be used as a deposit on a home.
With most mortgages, you borrow the money you need to purchase a property, and pay back the loan over a set period of time, typically between 25-40 years.
Interest is the price you pay for borrowing money. The amount of interest you’ll pay on a mortgage will typically change throughout the time you have it.
If you ‘lock in’ for a fixed term, it means you’ll pay the same interest for a certain length of time; or you can choose something called a variable rate mortgage.
Interest on a mortgage is calculated as a percentage of what you borrow, so if you’re given a 2% interest rate, and borrow £200,000, you’ll pay £4,000 in interest each year, though your interest rate is likely to change during the full term of your mortgage.
As you pay down your mortgage, the amount of interest you’ll pay will gradually decrease, for instance, lets say you’ve paid off £20,000 of your £200,000 mortgage and your remaining balance is £180,000, if your interest rate is still 2%, you’ll pay £3,600 in interest.
There are a range of mortgage options available, with different repayment terms and interest rates, and the best one for you will depend on your personal circumstances.
Mortgages can be either repayment mortgages or interest only mortgages.
With repayment mortgages, your monthly repayments will pay off some of your loan with added interest. Repayment mortgages are the most common type of mortgage, and as long as you keep up repayments, you’re guaranteed to have paid off your mortgage by the end of your mortgage term.
With interest only mortgages, you only pay the interest charged on the mortgage each month, but you don’t pay off the loan. Instead, at the end of your mortgage term, you’ll still owe the full amount you borrowed, and will be expected to pay it back in full.
Interest-only mortgages can look tempting because your monthly repayments will be lower, but you’ll need to be disciplined and know precisely how you plan to pay off the mortgage at the end of the term.
If you aren’t paying off your mortgage, and only repaying the interest on it, you’re risking being in what’s known as ‘negative equity’ if house prices fall.
Negative equity means that you owe more than the house is worth, and even selling the property wouldn’t pay off the money you owe. Being in negative equity can feel overwhelming, and is a significant risk of interest-only mortgages, unless you have a plan to repay back your mortgage.
Typically you’ll pay more interest with an interest only mortgage, because the interest is calculated on the entire mortgage amount throughout the whole term of the mortgage.
In contrast, with repayment mortgages, interest is calculated on the remaining balance of the mortgage, so the interest charged reduces over time.
There’s several types of repayment mortgages to choose from, including:
With a fixed-rate mortgage, you'll pay the same amount of interest for a set period of your mortgage term, commonly two, or five years.
Fixed rate mortgages can be helpful with budgeting, knowing your mortgage repayments will be the same each month.
It's common for people to "remortgage" at the end of their fixed rate deal, in order to get another fixed rate deal.
Tracker mortgages are a type of variable rate mortgage, which means the interest rate, and therefore your monthly repayments can change.
Tracker mortgages follow the Bank of England base rate, with a certain percentage on top, such as base rate plus 3%. So if the base rate was 3%, you’d pay 6% interest.
Tracker mortgages are also typically only available for a set period, just like fixed rate mortgages. Whilst your repayments can vary, people use tracker mortgages because they can benefit if the base rate drops, but you’ll also end up paying more if it rises.
Discounted mortgages are another type of variable rate mortgage, that are offered for an introductory period.
They’re offered as lenders standard variable rate (SVR) minus a certain percentage. So if the lenders standard variable rate is currently 6%, and your discount rate is SVR minus 2% you’ll pay 4% interest.
You could benefit if your lenders SVR goes down, though you’ll end up paying more if the lender raises their SVR.
Standard variable rate mortgages are a variable rate mortgage where you simply pay the lenders SVR for the duration of your mortgage.
SVR mortgages can be expensive, because lenders can set their SVR at whatever they want. SVRs don’t need to follow the Bank of England base rate, though it’s common for lenders to increase their SVRs as the base rate increases. They’re often not as quick to do so when the base rate falls.
If you have an introductory offer such as a fixed rate mortgage or discount mortgage, it will change to a SVR mortgage if you don’t remortgage at the end of the fixed period.
Offset mortgages are linked to a savings account. The money you have in your savings is used to “offset” the interest you’re charged on your mortgage.
Whilst this can be one way to lower your monthly mortgage repayments, you won’t earn any interest on your savings. So for example, if you have a mortgage of £260,000 , and you have £20,000 in your linked savings, you will only pay interest on £240,000 rather than the full £260,000.
If you have a large amount in savings, an offset mortgage could be an effective way to reduce your mortgage interest, but won’t make as much difference if you only have a small savings pot.
A guarantor mortgage is when you get someone, usually a friend or relative, to agree to repay your mortgage if you get into financial difficulty, and are unable to repay. This type of mortgage is typically used for those with limited credit history, because it can help them to qualify for a loan that they may not be able to get on their own.
A buy-to-let mortgage helps you to buy a property in order to to rent in out.
A self-build mortgage is a way to fund building your own house.
When you take out a mortgage, you’ll need to put down a deposit. Your deposit will be a percentage of the property's value; typically you’ll need to provide a deposit of at least 5%.
However, 5% deposit mortgages are only offered by a limited number of providers, and to get the best mortgage rates, you’ll often need at least a 20% deposit.
In the majority of cases, yes, you’ll need to make sure that you have the full deposit amount before you apply for a mortgage.
Typically, in order to put an offer in on a property, you’ll need something known as ‘proof of funds’.
The sellers estate agent will ask for proof of funds before they process your offer. A part of your proof of funds will be evidence that you have the sufficient deposit, along with a mortgage in principle to afford the offer you’ve made on the property.
During the mortgage application process, you’ll need to prove where your deposit came from.
The evidence you need to provide will depend on where your deposit came from.
Most accepted sources for deposits are:
When looking for a mortgage, you’ll often see LTV or Loan to value mentioned. LTV is the amount of money you borrow versus the value of your property.
It is shown as a percentage - for example, if your house is worth £300,000, and you put down a deposit of £60,000 and borrowed £240,000, you’d have an LTV of 80%.
Before you first start looking to purchase a home, it’s a good idea to use an online mortgage calculator to determine how much you could borrow and how much deposit you’ll need. This will help you to work out which properties you could afford to buy.
When you start house hunting, you need something called a ‘decision in principle’ (DIP) in place before you make an offer on a house. This is because, to have an offer accepted, the sellers estate agent will ask for proof of funds. This is evidence that between your deposit and your DIP, you can actually afford the offer you’re making on the property.
A decision in principle (DIP), also known as an agreement in principle (AIP) or mortgage in principle, is an indication from a lender, or broker, of how much you will be able to afford to borrow.
Getting a DIP is usually a simple process and can only take a few minutes to get. You can apply for a decision in principle online, by phone or in high-street branches of banks.
Mortgage lenders will check your credit history when you apply for a mortgage in principle. Some lenders will only perform a “soft search” which won’t affect your credit score, but others will perform a hard credit search, which will leave a record on your credit report.
It’s a good idea to check before applying for a DIP whether the lender will perform a hard or soft search, because too many hard credit searches over a short period of time can have a negative impact on your credit score.
Decisions in principle typically last between 30 and 90 days, but can usually be renewed if they run out before you’ve made an offer on a property.
It’s important to remember a DIP isn’t a guarantee that you’ll be able to get a mortgage, or that you’ll definitely be able to borrow the amount on your DIP.
It’s a good idea to look at properties that don’t require the full amount stated on your DIP, so you don’t overstretch yourself financially or fall in love with a property, only for your mortgage lender to turn around and say they can’t lend you the full amount on your DIP.
Once you’ve made an offer on a property and it’s been accepted, it’s time to apply for a mortgage.
Mortgage brokers, also known as mortgage advisors, will be able to search the market to find a mortgage lender willing to lend you the money for a property. They will also be able to advise you of the best deals available to you.
Using a mortgage advisor will typically improve your chances of successfully getting a mortgage.
Different lenders will have different criteria for mortgage applicants, and a mortgage broker will know which lenders will be most suitable for your circumstances. Mortgage brokers will also help you through the application process, and help to arrange the mortgage for you.
Many mortgage brokers compare the whole of market, which means they will look at all possible options for your mortgage. Others, may be tied to certain lenders.
Some mortgage brokers will charge a fee, others will receive commission from the lender upon successful completion of the mortgage. It’s common for mortgage brokers to have exclusive deals with lenders, meaning you may be able to get a better deal by going through a broker.
It’s a good idea to shop around to find a mortgage broker that suits your needs.
The actual mortgage application itself is not a lengthy process, as long as you have all the necessary financial information and documents ready.
However, the whole mortgage application process can typically take between two and six weeks. Whilst it may seem daunting, most of the application process is usually quite smooth and simple, the majority of this time is for the lender to process your application and reach a decision.
In some cases, your mortgage lender may ask for more information during this time. They will also perform a hard credit check and carry out a valuation of the property you’re trying to buy.
When you’re applying for a mortgage, your lender will want to make sure that you can afford your mortgage repayments, because of this, they are likely to ask you a number of questions about your current financial situation and financial history.
Common questions will include:
Whilst it might feel a bit invasive, the questions are designed to check that you'll be able to afford the monthly mortgage repayments, even if your circumstances changed.
During your mortgage application, you are likely to need to provide:
When your mortgage application is approved, your mortgage lender will give you a mortgage offer, which you will need to sign and accept. Mortgage offers are usually valid for six months, and at this point, the lender has agreed to lend you the money you need to buy your property.
Your mortgage offer will contain all the information about your mortgage, such as your terms and conditions, so it’s important to check all the information is correct and as you expected before you accept the offer.
Once you’ve received and accepted your mortgage offer, you’ll need to pay a solicitor to finish sorting out the rest of the purchase through to completion.
This can sometimes be complicated and take a lot of time, so if your mortgage offer ends up running out, don’t panic, some lenders will extend your mortgage offer, or you can reapply for a new mortgage.
If you do have to reapply, remember that you’re not guaranteed to get the same deal as you did before, especially if interest rates have risen since you first applied.
When it’s time to move in, the lender will transfer the mortgage funds to your solicitor, which is when you’ll also need to transfer your deposit. Once your solicitor receives the funds, they will send them to the sellers solicitor, and you’ll be able to collect the keys to your new property.
Now all you have to do is unpack, keep up your mortgage repayments and enjoy your new home.
Remortgaging is when you move your mortgage from one lender to another.
Most of the time, people will remortgage when they come to the end of their fixed rate deal, as a way to get another fixed rate deal. People will also remortgage if they want to borrow more money on their mortgage for things like home improvements.
Remortgaging follows a similar process to taking out a new mortgage, and it’s a good idea to use a mortgage broker when remortgaging.
Before you remortgage, it’s a good idea to work out how much it will cost you because many mortgages will have an early repayment charge, plus you’ll need to pay solicitors fees and any application and valuation fees from your new lender.
Whilst this may sound expensive, remortgaging to a better deal may end up saving you money in the long run. Because mortgages are typically for a large amount of money, even a 1% lower interest rate for five years can make a significant difference to your monthly repayments and the amount you’ll repay overall.
If you’re lucky enough to afford a house without having to borrow money, then you absolutely can buy a house without a mortgage.
Buying a house with money you’ve saved is the most obvious way to become a homeowner without a mortgage, but it’s not the only way.
Another way is to use a shared ownership scheme. This is where you buy a portion of a property, and pay rent on the rest.
The government’s shared ownership scheme is available to first time buyers who can’t afford a deposit. The shared ownership scheme allows you to purchase between 25% and 75% of a property, using either a mortgage or savings.
If you use a mortgage to buy your share, you could end up paying more per month because you’ll have to pay your mortgage and the rent on the portion you don’t own, so it’s important to work out overall costs before committing to anything.
If you purchase a property using a shared ownership scheme, you can buy more shares in your home in the future, this is known as staircasing.
If a lender believes you can afford another mortgage, then you are absolutely able to have more than one mortgage.
Legally, there is no limit on how many mortgages you can have, it’s down to the lenders to assess your affordability, in the same way they do for your first mortgage.
Some lenders may have a limit on how many mortgages you can have.
One of the most common reasons to get a second mortgage is to buy a property with the intention of getting it ready to rent out, earning you income as a landlord.
For this, you’ll need to apply for a buy-to-let mortgage. The majority of buy-to-let mortgages are interest only, so you’ll need to consider how you’ll pay the capital back at the end of the mortgage term.
Buy-to-let mortgages typically require larger deposits than residential mortgages, usually at least 25%.
If you plan to get a second residential mortgage, you’ll need to prove that you’re planning on residing in both of your properties, and that you won’t be renting the second property out.
The information provided does not constitute financial advice, it’s always important to do your own research to ensure a financial product is right for your circumstances. If you’re unsure you should contact an independent financial advisor.
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