How do mortgages work?
Mortgages are a type of loan that are used to buy a property. The mortgage is secured against the value of the property. You’ll make monthly repayments to the bank or building society you borrowed from until the mortgage is paid off.
Monthly mortgage payments are worked out using the following information:
- Property value
- Deposit as a % of the property value
- How much you need to borrow
- Mortgage term from 5-40 years
- Type of mortgage
- Introductory interest rate periods
The property value is where it all starts. This is what shapes how much deposit you’ll need, what you’ll need to borrow for a mortgage, and how much you could be paying back each month.
Your deposit makes up a percentage of the property price. Usually, you’ll need a minimum of 10% of the property’s value to get a mortgage, although it’s possible to put down a 5% deposit with certain government schemes.
The amount you need to borrow depends on the size of your deposit and the property price. The amount left over after you minus the deposit from the property value gives you the amount you need to borrow.
The mortgage ‘term’ is the period you choose to hold or repay the mortgage over. It can be anything from 5 to 40 years, depending on the lender.
The type of mortgage you choose dictates how you repay the amount you’ve borrowed over the term of the mortgage. For example, an interest-only mortgage means you only pay back the interest charged on the mortgage, not the amount you borrowed. At the end of the mortgage term you can choose to pay back the total amount you borrowed in one payment or take out another mortgage.
Introductory interest rate periods are common across all mortgage types. They offer a lower rate of interest for the first 2 to 10 years of the mortgage before moving to the lender’s standard variable rate (SVR).
What mortgage do I need?
There are a number of different mortgages types out there, each suited to the different steps of the property ladder. The main types of mortgages are:
- First-time buyer
- Second mortgage
- Porting your mortgage
- Buy-to-let mortgages
A first-time buyer mortgage is for those looking to buy their first property in the UK. Lenders will add incentives like cashback promises, help towards legal fees or free valuations.
A remortgage happens when your current mortgage deal changes. This will be either because you are switching to a new lender or taking out a different deal with your current lender. When looking to remortgage, it’s worth considering deals from your current lender as well as deals from new lenders, as these can be cheaper than your current lender deal.
A second mortgage, also known as a ‘second charge mortgage’, is where a second mortgage is taken out on your home. It’s a secured loan that will run alongside your first mortgage and is secured against the equity in your property. You might take out a second mortgage if for example, you need a lump sum but are struggling to get approved for a loan.
Equity is the value of the percentage you own in your property. A second mortgage allows you to use that equity to secure another loan. For example, your home could be worth £200,000 and you have £120,000 left to pay on your mortgage. So you own 40% of the home, and £80,000 can be used as equity.
Porting your mortgage or home purchase is when you’re looking to buy your next property and you’ll either need to take out a new loan or stick with your current mortgage deal and transfer it to the new property.
A buy-to-let mortgage is suitable if you’re looking to invest in a property to rent out to tenants rather than live in it yourself. Like other mortgage types, it’s a secured loan that’s used against the property, whether it’s a house or flat.
Types of mortgage rates
Choosing the right mortgage rate is an important step in getting a good deal. Some mortgages have fixed interest rates, and some have variable, so change regularly. It’s important you understand the different types to be able to choose one best suited to your financial situation.
- Fixed-rate mortgage
- Variable-rate mortgage
- Tracker mortgage rate
- Discount mortgage rate
- Standard variable rate mortgage
- Offset mortgage
- Interest-only mortgage
A fixed-rate mortgage has an interest rate that’s fixed for the agreed term. It starts with an introductory rate usually lasting 2 - 10 years before moving to the lender’s standard variable rate (SVR). If you’ve worked out a monthly budget and want to stick to it, a fixed-rate mortgage could be exactly what you’re after.
Variable-rate mortgage interest rates are tied to your chosen bank or building society’s base rate or the Bank of England’s base rate. This means that the interest rate, and your payments, can fluctuate during the mortgage term. This means you could pay less or more every month.
Tracker mortgage rates are tied directly to the Bank of England base rate plus a set percentage. For example, if the base rate was 1% and the set percentage was 1.5%, you’d pay 2.5% interest on your monthly payment. The mortgage payment changes with this base rate, so you could pay less or more each month.
A discount mortgage rate also has a variable interest rate and is based on the standard variable rate (SVR) set by your lender. It usually lasts 1 - 5 years. If rates drop, so will your repayments. But like all variable rates, they could also rise and increase your outgoings.
A standard variable rate mortgage (SVR) is what your lender will switch you to when your introductory period or any other follow-on rate periods end. Each bank or building society sets their own SVR. It tends to be a higher interest rate compared to other types of mortgages. An SVR is the default interest rate you’ll be charged until you complete a new remortgage deal or pay off your mortgage in full.
An offset mortgage is probably the most complex type of mortgage rate. An offset mortgage links your savings to your mortgage deal. You pay less interest on the debt as the interest you’d get from your savings is used to offset the mortgage interest. An offset mortgage is available on fixed or variable rates and can be seen as a great way to pay off your mortgage quickly.
Interest-only mortgages are where you only pay back the interest on the loan you’ve borrowed each month. When your mortgage term comes to an end, you’ll still owe exactly what you borrowed at the start. This type of mortgage isn’t widely available since there’s a risk of your home getting repossessed if you’re unable to keep up with the payments. You should only choose this option if you know exactly how you’ll pay it back when the term comes to an end and can show evidence to the lender of a repayment strategy.
What else do I need to look out for when looking for a mortgage?
A good interest rate shouldn’t be the only thing to keep an eye on to get the best deal. Other things to look out for to help you keep payments down are:
The length of mortgage term is something to consider. Despite longer mortgage terms having lower repayments over a longer period, you may be paying a lot more overall. Take time to compare different deals and make sure to look at short and long-term benefits.
Consider the overall fees of any mortgage deal. Good interest rates shouldn’t completely sway your decision when it comes to choosing a mortgage. Steep fees could mean that a higher interest rate deal works out cheaper overall if it has lower or no fees at all. It’s worth working out the total cost over the whole mortgage term on a few potential deals to see what’s best for your financial situation.
Initial period total cost is a calculation that helps you better compare the trade-off between products with higher rates and lower fees against products with lower rates and higher fees. It shows you the total amount you’ll pay in the initial period, including all your repayments, all of your fees, and subtracting any incentives like cashback.
Your credit history and credit score are taken into account when getting a mortgage. A good credit history can help increase the amount of mortgage deals available to you as it shows you’ve paid back loans, credit cards or any card payments on time, and that you’re reliable to lend to. You can help improve your score by paying your bills on time, checking your details are up to date on the electoral roll and closing any card accounts you don’t use.
Remember, if you’re making a joint application, the lender will look at both your credit histories.
Saving for a deposit is helpful, and the more you save, the less you’ll need to borrow for a mortgage. Having a bigger deposit also means you may have access to a wider variety of lenders and more competitive mortgage rates.
Need more help?
There isn’t a specific amount of time you have to wait before your mortgage application gets approved. How long approval takes depends on:
- The outcome of the mortgage survey
- If you’re involved in a chain
- How reliable and steady your income is
- How good your credit rating/history is
With variable rate mortgages, the rates normally change in line with the Bank of England’s base rate but can also change with your building society’s base rate. If your mortgage has a fixed interest rate, your payments won’t be affected until after your term ends.
There are a few options for your mortgage when you move home. If you want to keep your current mortgage, you can do what’s called ‘porting’ your mortgage. If your current deal has a good interest rate, this could be a smart move. It’s worth checking with your current provider first to see if they’ll let you port your mortgage.
If you’re looking to buy a more expensive house, you might need to borrow more money. So the mortgage lender will probably ask you to go through a few checks to make sure you can afford the increased payments.
If you don’t want to port or increase your mortgage, you could look for a brand-new mortgage deal with better rates. Whilst this might seem like a better option for saving money, you might need to take fees into account. If your current provider charges early repayment fees, make sure to work out if switching will actually end up costing you more.
If you’re thinking about paying off your mortgage early, some lenders may let you make increased monthly payments. Or you might be able to put down a lump sum as one large mortgage repayment. Get in touch with your mortgage provider to check what rules they have around overpaying on your mortgage.
When you take out a mortgage, you’ll have to pay a number of fees and charges. The amount you pay depends on a number of things, like your financial situation, the mortgage product or the mortgage provider. Because every deal is different, it’s difficult to give an estimate on how much these fees will cost. If you’re worried about these costs, it might be a good idea to contact the provider you’re looking at to see if they can give you a rough idea.
Loan to value, or LTV, is a percentage that shows how much you’ve borrowed based on the value of a property. Let’s take an example. If your property is worth £300,000 and you put down a deposit of £30,000, then your mortgage is £270,000. As your deposit is 10% of the property’s value, your LTV is 90%.
A repayment mortgage is exactly how it sounds. You repay part of your mortgage every month. Each repayment includes part of the money you borrowed and part of the interest that the provider is charging you. At the end of the mortgage term, you’ll have paid off the full amount you borrowed. Mortgage terms normally last for 25 to 35 years. Once it’s all been fully paid off, you’ll own your property outright.
An interest-only mortgage is where your monthly payments only go towards paying off the interest on your mortgage. So, your payments won’t be making a dent on the total amount you borrowed. At the end of the mortgage term, you’ll still have to pay back the total balance of money you borrowed. Once you’ve done that, you’ll own your property outright.
Having an interest-only mortgage means your payments will be lower than a repayment mortgage. But if you’re looking at interest-only, make sure you know the financial implications.
What our expert says
There’s no reason why you shouldn’t compare mortgages like you would car or home insurance. A mortgage is a big financial investment so finding the best deal for you could help massively in the long run. We show rates, fees and incentives to give you the best idea possible of what to expect from each lender’s mortgage deals.
Personal finance expert