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You Are Here: Home > Personal Finance > Mortgages > The basics
Mortgages: The Basics
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I once read some statistic stating that people often spend more time researching where to go on their summer holidays than researching the best mortgage deal.

The reason is probably that mortgages and personal finance in general are not the most riveting subject, whereas sunny beaches and swimming pools are easier to read about.

However, as a mortgage is probably the biggest and most important financial product you'll buy throughout your lifetime, it really does pay dividends to properly research what you're buying. Otherwise you face the real prospect of being sold an overpriced deal with all sorts of nasty strings attached.

But the good news is twofold -

  1. Educating yourself about mortgages isn't hard, just a few hours will go a long way, and
  2. Getting the right deal will probably mean you save thousands of pounds, both initially when you sign up and more importantly over the lifetime of the loan
Why not start by downloading our free guide - How to get the right mortgage at the best price.
What is a mortgage - How do they work
A mortgage is nothing more than a long term loan that is secured against the value of a property. 'Secured' means that if you are unable to repay the loan, either in part or in full, the mortgage company has the right to sell the property and reclaim its money.

A good way to describe how mortgages work is to look at 4 important questions that have to be answered -

  1. How much can I borrow?
  2. The costs and how the interest is charged?
  3. What style of mortgage?
  4. How long will the loan last?

1. How much can I borrow

Before the early 1990s, when the banks weren't as sophisticated or aggressive as they are now, it was in most cases only possible to borrow a maximum of 3x or maybe 3.5x your annual salary. If you earn £30,000 a year the maximum loan would be about £100,000.

But now as lenders have become much more flexible it's often possible to borrow 6 or 7 times your salary depending on your circumstances. Many lenders will look at both your salary and your ability to repay the loan.

For example, a single male with no dependants will probably have far more disposable income than a married man earning the same salary but with 3 children and a wife who doesn't work. This is often called 'affordability' and I go into more detail below.

Deposits are important - The larger the better
A deposit is the amount of cash that's initially put down to buy a property. If a flat is worth £100,000 and you put up £20,000 in cash the deposit if obviously 20% and the mortgage will be for 80% of the value. This 80% is referred to as Loan-To Value (LTV) and is discussed in more detail on this page.

Mortgage lenders love deposits, the higher the better, as this gives them an extra cushion should the property fall in value. So the higher deposit you pay the more money can usually be borrowed. For example -

  • Using a flat worth £100k as an example
  • If you put up a 10% deposit a mortgage lender might offer you a maximum loan of 4.5x your income
  • But if you put up £30k (30%) the lender might offer you 6x your income

Some lenders now, after having their hands burnt by the recent property slump, are now insisting on ever higher deposits. During the recent property boom of 2001-2006 many lenders were only too happy to lend 100% of the property's value (and some, Northern Rock as an example ill- advisedly offered 125% mortgages but look where that got them).

So at the time of writing it's still possible to get a 100% mortgage depending on your circumstances but in reality many people might struggle to get a decent loan, or even be approved unless they put up at least a 10% deposit.

Affordability - The ability to repay a mortgage

When deciding how much to lend your personal circumstances are often considered. What the lender is looking at is your ability to cover the payments.

Therefore a single man with no wife or children earning £40,000 a year will probably be offered a larger sum than a married man with 2 children also earning £40,000 a year. This makes sense as the single man won't have to pay nearly as much to live on a monthly basis as the man supporting a family.

How affordability is calculated
Every mortgage lender will have their own methods but they all work on similar principles, such as -
  • Proof of income
  • Number of dependants (children or others in your care)
  • Monthly debt commitments (you might for example have £12k in Credit Card debts)
  • Details of your average monthly budget and maybe bank statements to try to prove this over the past 12 months
Overall the more you want to borrow the more thorough your financial circumstances are likely to be investigated.

2. The costs and how interest is charged

Mortgage costs can be split into 2 separate areas -
  1. The monthly repayments on the loan principal (you have the choice whether to pay this or not), and
  2. The initial costs and fees of the loan
For the monthly repayment totals at different interest rates look at the table below. I have split the payments into 2 different styles of mortgages, repayment and interest only. The different styles of mortgages are discussed in more detail on this page but here's a short summary -
  • Repayment mortgage - If you're lent £100,000 over 25 years the monthly repayment will be made up of both the interest bill and a contribution to repaying the £100k debt. This means that in 25 years the full balance will have been paid off

  • Interest only mortgage - You're again lent £100k over 25 years but the monthly payment is for the interest only. So after 25 years you'll still be left with the original loan (often called the 'principal) of £100k to pay off. The monthly repayments are obviously cheaper for this style of mortgage

Difference in mortgage payments : Repayment mortgage versus interest only style

Interest rate
Repayment mortgage
Cost per £10,000 borrowed
Interest only mortgage
Cost per £10,000 borrowed
3%
£47.90
£25.00
3.5%
£50.60
£29.20
4%
£53.30
£33.30
4.5%
£56.20
£37.50
5%
£59.10
£41.70
5.5%
£62.10
£45.80
6%
£65.20
£50.00
6.5%
£68.30
£54.20
7%
£71.50
£58.30
7.5%
£74.80
£62.50
8%
£78.10
£66.70
8.5%
£81.40
£70.90
9%
£84.80
£75.00
Both mortgages are for a period of 25 years
  • If you borrowed £100k via a repayment mortgage with interest rates at 5% your monthly payment would be £591 (note, the figures in the table above are per £10,000 borrowed)
  • The monthly payment for a £100k borrowed at 5% but interest only style would be £417

What is interesting to note is that when interest rates are low (3% or under) an interest only mortgages is almost half the cost of a repayment one. But when rates push significantly higher (9% or above) the difference is marginal.

Interest only mortgages and all the other variations are discussed in more depth on this page.

Mortgage Fees and charges

It's critical not just to focus on the interest rate and monthly repayments of a mortgage, otherwise you're opening yourself to the very real risk of being profit fodder for the lender as they often try to load you up with all sorts of expensive fees and charges.

Remember, that sadly the banks have a long history of playing games with consumers so we must always be on our guard.

Mortgage fees and charges is such an important topic that there is a dedicated page discussing all the relevant fees, what you have to pay and what you don't, and more importantly how to avoid overpaying.

3. What style of mortgage

At any one time there are over 3,000 different mortgages on the market and this can seem daunting at first, especially if you're new to the mortgage world. But think of this as good news because it promotes competition, which normally means cheaper prices, and above all flexibility.

Flexibility with financial products, especially one as large as a mortgage is so important. For example, do you know what your health or financial situation will be in a couple of years or even 5 years down the line? Of course you don't so signing up to a rigid financial product is something to be avoided at all costs.

This is why when you're looking at different mortgage styles you must always try to go for the most flexible products, and mortgage flexibility relates to -

  • The ability to underpay - if money is tight for a few months many lenders will accept much lower payments with no financial penalties

  • The ability to overpay - perhaps you got paid a £3,000 bonus and used £2,000 of it to reduce the overall size of your loan

  • Little or no early repayment charges - what happens if you want to pay the loan off in full and move to a different lender - so-called remortgaging. You don't want to be charged a fee (small amounts are ok) unless you've signed up for a special deal lasting a few years (a fixed rate or discount etc)

  • See Secret 3 - Buy simple and flexible - you can't read the future - which is one of this site's 10 Secrets to Good Personal Finance
The different styles of mortgages

As indicated there are literally 1,000s of different mortgages on the market at any one time and these are split into various different styles such as repayment, interest only, offset etc.

4. The Length of the Mortgage

25 years in length used to be the only type of mortgage available back in the old inflexible days.

But now the financial service industry and the clients are so much more sophisticated that it is possible to tailor almost any kind of mortgage to suit both borrower and lender.

For example if you want a mortgage for £121,454 payable over 12.75 years (153 months), that wouldn't be a problem to sort out.

But for most people the amount borrowed in relation to how much you can afford to pay monthly are the 2 dominant points to consider when deciding on the length of a mortgage. In a perfect world we'd all want a mortgage for around 10 years before paying it off in full. But sadly most people don't earn enough to make the large monthly payments which this would entail.

So even with the revolution in the mortgages business over the last 2 decades 20-25 years is still the standard length, although there's been some recent press reports of banks willing to lend for 30-50 year mortgages.

LearnMoney Comment :
Mortgages on the whole are excellent financial products and both parties, the borrower and the lender, get a pretty good deal. The main advantage for borrowers is the competitive interest rates as no other loan is cheaper.

Use the information contained on this page and from the Mortgage Section in general to make sure you fully research the ins and outs of these products. Education is so important and it's the only way that you can be sure of getting the right mortgage at the best price.

Conversely, a lack of education is the number one reason why so many get taken advantage of when sorting out home loans.

We are in control - Not the lenders

Finally, realise that consumers normally have the upper hand over the lenders when looking for a mortgage. We have the luxury of choosing who to do business with (assuming our credit files are sound), not the other way around.

Believe me, the banks and building societies are desperate to sign up new business so -

  • Take your time
  • Do your research
  • Never rush into anything
  • Use the how to pick a good mortgage guide and you'll have the confidence and knowledge to get a great deal
FREE Report: How to get the right mortgage at the best price
It takes just 4 easy steps
How to make sure you don't overpay on charges
Learn to quickly sort through the market maze
How to get a flexible deal - why this is so important
Download the Free Report
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