A Beginners Guide to Mortgages

A Beginners Guide to Mortgages: Everything You Need to know but Were Maybe too Embarrassed to Ask! 

Buying your first home is an exciting, yet often overwhelming, experience. One of the biggest hurdles for many buyers, whether for the first time or existing homeowners, is understanding how mortgages work. No matter where you are in your homeownership journey, it’s important to understand the basics of mortgages to ensure you are on the most sustainable path to owning your own home. 

In this guide, I’ll break down the essential things you need to know about mortgages and how they work, so you can feel more confident and prepared when the time comes to secure your dream home. 

1. What is a Mortgage? 

A mortgage is a type of loan that is used to buy a property. When you take out a mortgage, you borrow money from a lender (usually a bank or building society) to pay for a house, flat, or other property. In return, you agree to pay the money back over a set period of time, which for First Time Buyers is typically between 25 and 30 years, with interest added on top. 

If you don’t pay back the mortgage as agreed, the lender can take legal action to repossess the property. This is why it’s so important to ensure you can afford the monthly payments before you take out a mortgage. 

2. How Do Mortgages Work in the UK? 

In the UK, there are a few key elements that come into play when taking out a mortgage: 

• Deposit: When you buy a property, it can be advantageous to pay a deposit upfront. A typical deposit is around 5%-20% of the property’s value. The more deposit you can put down, the lower your loan-to-value (LTV) ratio will be, and this can lead to more favorable mortgage terms. 
• Loan-to-Value (LTV): This is the ratio of the mortgage loan amount compared to the value of the property you’re buying. For example, if you’re buying a property worth £200,000 and taking out a mortgage of £180,000, your LTV would be 90%. Generally, the higher the LTV, the more risk the lender takes on, which usually result in higher interest rates. 
• Interest Rates: When you take out a mortgage, the lender will charge you interest. This can be either a fixed or variable rate, which we’ll explore in more detail later on. 

3. Types of Mortgages 

There are several types of mortgages available, and it’s important to choose the one that best fits your circumstances. When it comes to choosing a deal, there are 2 main characteristics of a mortgage to consider; how your interest is calculated and, how you will repay the loan: 

Interest calculation, 

• Fixed-Rate Mortgage: With a fixed-rate mortgage, the interest rate stays the same for a set period (usually 2, 3, 5, or 10 years). This gives you the security of knowing exactly how much your monthly payments will be during that time. It can be a great option if you prefer stability in your budget. 
• Variable-Rate Mortgage: A variable-rate mortgage means the interest rate can change, either in line with the Bank of England base rate, known as a Tracker Mortgage – or according to the lender’s own decisions, the lenders Standard Variable Rate, or SVR. While both variable options may come with lower introductory rates, at the end of any introductory offer period the rates may go up and your monthly repayments will increase along with it.  

Repayment type, 

• Repayment Mortgage: With a repayment mortgage, your monthly repayment includes both the interest and an element of the loan amount itself each month. Over time, the balance of your loan decreases until it’s paid off at the end of the term. 
• Interest-Only Mortgage: This type of mortgage allows you to pay only the interest on the loan for a set period, rather than paying off the loan itself. While this can result in lower monthly payments in the short term, it means you’ll still owe the full loan amount at the end of the term, which can be risky if you’re not prepared to repay the outstanding principal amount at the end of your Term. 

4. How Much Deposit Do You Need? 

In the UK, the size of the deposit you need will depend on the lender and the property you’re buying. Typically, first-time buyers are expected to put down a deposit of at least 5%-10% of the property’s value. While there are some lenders who offer 100%LTV deals if you meet certain criteria, having a larger deposit can make a difference in the mortgage deals available to you, as lenders typically offer better rates to buyers who can afford a higher deposit. This is normally broken down in 5% brackets, with the best deals available at 60%LTV, to those with a 40% deposit, or equivalent in equity when remortgaging. 

For example, if you’re looking at a £200,000 home, a 5% deposit would be £10,000, while a 20% deposit would be £40,000. If you’re able to save for a larger deposit, you might be able to get a more affordable mortgage in the long run. 

5. What to Expect During the Mortgage Application Process 

The process of applying for a mortgage can seem complicated, but breaking it down into steps can help:

1. Understanding your Financial Position:Before you start house hunting, it’s a good idea to understand your financial position and your potential budget. Speaking with a Mortgage Adviser can help you to understand your current position, explain the costs associated with buying and moving home and what your future costs may be.   
2. Get an Agreement in Principle (AIP): Once you have an understanding of your financials your adviser may seek to get you an agreement in principle from a lender. This is a statement from the lender saying that, based on your financial situation, they are willing to lend you a certain amount. It’s not a guarantee, but it gives you an idea of how much you can borrow. 
3. Find Your Property: Once you have an AIP, you can start looking for properties within your budget. Once you find a home you like, you’ll make an offer. 
4. Formal Mortgage Application: After your offer is accepted, your adviser will help you with and submit your Full Mortgage Application. The lender will assess your application, check your credit report, and look at your financial situation to decide if they’ll lend to you. 
5. Valuation and Survey: The lender will typically carry out a valuation of the property to make sure it’s worth the amount you want to borrow. It’s also a good idea to arrange a homebuyer’s survey to check for any potential issues with the property. 
6. Mortgage Offer: If everything checks out, the lender will send you a formal mortgage offer. Once you’ve accepted it, you can move on to exchange contracts and complete the sale. 

6. What Can You Afford? 

When you’re thinking about how much mortgage you can afford, it’s not just about how much you can borrow—it’s about how much you can realistically repay each month. Lenders will typically look at your income, outgoings, and credit history to assess how much you can afford. 

As a general rule of thumb, most lenders will lend up to 4-4.5 times your annual income, but you’ll need to factor in other debts (like credit cards and loans) and day-to-day expenses when deciding what you can comfortably afford. 

Conclusion 

Understanding the basics of mortgages is the first step towards becoming a confident homebuyer. From knowing what a mortgage is, to understanding how interest rates and deposit sizes can affect your loan, this guide is just the start. Keep an eye out for further posts exploring how to choose the right type of mortgage for your needs and many other topics. 

If you’re unsure about any part of the mortgage process or need advice tailored to your personal situation, don’t hesitate to get in touch. As a mortgage adviser, I’m here to help guide you through every step of the journey to buying your new home. 

Your home may be repossessed if you do not keep up repayments on your mortgage

The information contained within was correct at the time of publication but is subject to change.