With the average UK property price at around £295,000, most would-be home buyers will need a mortgage to help fund their purchase.
Getting onto, or climbing, the property ladder typically involves “one of the biggest loans we will take out”, said the Which? Money team, as latest data from the Land Registry showed that prices are close to all-time highs. Given the amounts involved, understanding how repayments work is vital.
How mortgages work
Property purchase payments are usually “made up of two parts – your deposit and your mortgage” from a bank or building society, the Which? team said. “The larger your deposit, the smaller the mortgage you will need.”
This ratio is known as the loan-to-value ratio (LTV). So if you buy a home valued at £100,000 with a mortgage of £90,000 and a deposit of £10,000, the LTV ratio is 90%.
The amount that the borrower will repay depends on the lender’s interest rate and the term of the mortgage. According to trade organisation UK Finance, the average term of a UK home loan hit a record 30 years in June, up from 25.5 years in the early 2000s.
“Longer-term mortgages cost less per month because the repayments are spread over a longer-term,” said money.co.uk, but “your mortgage will cost you more overall because you will be charged more interest over a longer period”.
How mortgages are repaid
Most borrowers repay the interest and capital of their home loan each month, known as a repayment mortgage.
Some borrowers only pay interest each month, known as an interest-only mortgage. Although this may be “a cheaper option when it comes to monthly payments”, said Moneyfacts, “you need to ensure you have the money available to repay the loan at the end of the mortgage”.
Borrowers also have to choose between the options of a fixed-rate mortgage, where the monthly repayment remains the same for a set period such as five years, or a tracker mortgage, where the interest rate is typically linked to the Bank of England base rate. Monthly repayments on a tracker rise if the base rate goes up but get lower if it drops.
GoCompare has a handy tool to help calculate mortgage repayments:
Once a mortgage deal ends, the repayments change to the lender’s standard variable rate (SVR) unless a new deal is agreed. SVR rates are “typically higher than the available deals, and can also change at any time”, said Unbiased. “Being on an SVR mortgage can increase the overall cost of your repayments by a lot,” the financial advice site warned.
Most borrowers whose deal has ended can save cash by switching to a new deal with their existing or a new lender, known as remortgaging.
Where to get a mortgage
Homebuyers can get a mortgage direct from a bank or building society, but will only be offered the products provided by that lender. Alternatively, homebuyers can use a mortgage broker to “scour” the market for the “best deal”, usually for a fee, said Times Money Mentor . An adviser can also “recommend which lenders are more likely to approve your application” and may have access to loans that “aren’t widely available elsewhere”, the site added.
However you find the deal that you want, “you need to convince mortgage lenders that you’ve got the financial discipline required” to repay the debt, said MoneySavingExpert. Lenders will check your credit file – a record of how you manage debts held by credit reference agencies such as Experian, Equifax and TransUnion. Checking your credit reports are “up to scratch” is free and worthwhile, “as you don’t know which one(s) your mortgage lender will check”, the site advised.
A mortgage provider will want to see evidence of your income and expenditure in order to check if you can pass its affordability and interest rate stress tests. “This includes your earnings, how much you spend a month and the deposit you have put down on the property you’re purchasing,” said The Sun. You may need to provide documents such as utility bills, proof of benefits, passports, bank statements and your last three months’ payslips.
The lender may also charge a mortgage arrangement (product) fee, which “can be paid upfront or added to your mortgage but you’ll pay interest on it”, the paper explained.
Some mortgages don’t have fees but may charge higher interest rates, so comparing the total costs is important.
After choosing a mortgage, “if your application is pretty straightforward, it should take between two to four weeks from application to being approved”, although there is “no hard and fast rule”, said Online Mortgage Advisor.
What happens if you can’t repay a home loan
Technically, a lender can repossess your home if you fall behind on repayments.
If you are struggling, contact your lender, Many have a support team that could offer options “including restructuring repayments to temporarily reduce them or increase the length they are paid over”, said Yahoo! News.
Marc Shoffman is an award-winning freelance journalist, specialising in business, property and personal finance. He has a master’s degree in financial journalism from City University and has previously worked for the FT’s Financial Adviser, the financial podcast In For a Penny and MoneyWeek. This article is based on information first published on The Week’s sister site, MoneyWeek.com
