How do mortgages work?
Mortgages are a type of loan that you use to buy a property. The mortgage is secured against the value of the property itself. You make monthly repayments to the bank or building society you borrowed from until the mortgage is paid off. After that, the property belongs to you.
Monthly mortgage payments are worked out using the following information:
- Property value
- Deposit as a percentage 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 need, what you 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. Generally, the higher the deposit, the more attractive deals you can find.
The amount you need to borrow depends on the size of your deposit and the property price. The amount left over after you take out 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. 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 get 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 several 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 often add incentives like cashback promises, help towards legal fees or free valuations.
A remortgage happens when your current mortgage deal changes. This might be either because you're switching to a new lender or getting 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 might be cheaper than your current deal.
A second mortgage, also known as a ‘second charge mortgage’, is where you get a second mortgage on your home. It’s a secured loan that runs alongside your first mortgage and is secured against the equity in your property. You might get 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. Let's say your home is worth £200,000 and you have £120,000 left to pay on your mortgage. So you own 40% of the home, and £80,000 - the amount you've paid so far - can be used as equity.
Porting your mortgage or home purchase is when you’re looking to buy your next property. This means you either need to get 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 so you can choose one 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 an agreed term, usually 2-10 years. Then they go on 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 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 the interest rate, and your payments, can change during the mortgage term.
Tracker mortgage rates are tied directly to the Bank of England base rate plus a set percentage. For example, if the base rate was 2.25% and the set percentage was 1.5%, you’d pay 3.75% interest on your monthly payments. The mortgage payment changes with this base rate.
A discount mortgage rate also has a variable interest rate and is based on the SVR set by your lender. It usually lasts 1 - 5 years. If rates drop, so do your repayments. But like all variable rates, they could also rise.
A standard variable rate mortgage (SVR) is what your lender switches you to when your introductory period ends. Each bank or building society sets their own SVR and it tends to be a higher interest rate compared to other types of mortgages. An SVR is the default interest rate you’re charged until you get a new remortgage deal or pay off your mortgage in full.
An offset mortgage links your savings to your mortgage deal. You pay less interest on the debt as the interest you 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 quicker.
Interest-only mortgages are where you only pay back the interest each month. When your mortgage term comes to an end, you still owe exactly what you borrowed at the start. You should only choose this option if you know exactly how you’ll pay it back when the term comes to an end. You might also need to 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:
- Length of the mortgage term
- Overall fees of any mortgage deal
- Initial period costs
- Your credit history
- Your deposit
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 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, and a good credit history can help increase the amount of mortgage deals available to you. This 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
- Closing any card accounts you don’t use
Remember, if you’re making a joint application, the lender looks at both your credit histories.
Saving for a deposit is helpful, and the more you save, the less you 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.
First-time buyer schemes
There are several schemes to help first-time buyers, depending on where you're planning on buying your first home. The main schemes available are:
- Lifetime Individual Savings Account (LISA)
- Help to Buy - equity loan
- Help to buy - mortgage guarantee scheme
- Right to buy
Lifetime Individual Savings Account (LISA) gives you a 25% bonus on top of any savings you put into the account, up to a maximum of £1,000 a year. You must be aged between 18 and 39, and you can add up to £4,000 into the account each year.
Help to Buy equity loans are only available in England, and lets you borrow up to 20% (40% in London) of the purchase price of a neew-build property, interest-free. You need at least a 5% deposit to take advantage of this scheme, though. There is a similar scheme for first-time buyers in Wales. Help to Buy schemes in Scotland and Northern Ireland have closed.
Mortgage guarantee schemes allow first-time buyers to get a mortgage with a 5% deposit. The guarantee protects the lender for 80% of the purchase price, in the event that the house is repossessed.
Right to buy applies to first-time buyers in England and Northern Ireland. If you're a council house tenant, it gives you the option to buy the house at a discount.
There are more schemes, such as right to acquire and shared ownership, that apply to specific kinds of people. An excellent resource is the government's Own Your Home tool, which shows you exactly which schemes you might qualify for.
Need more help?
There isn’t a specific amount of time you have to wait before your mortgage application is 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
According to HomeOwners Alliance, you can expect to wait around 2-4 weeks between a valuation and a mortgage offer, on average.
With variable rate mortgages, the rates normally change in line with the Bank of England’s base rate but can also change with your lender's base rate. If your mortgage has a fixed interest rate, your payments aren't 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 'port' your mortgage over to the new property. 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 might 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. While 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 would actually end up costing you more.
If you’re thinking about paying off your mortgage early, some lenders might let you make increased monthly payments. Or you might be able to put down a lump sum as a single large mortgage overpayment. Some lenders might have limits on how much you can do before being charged, though. Get in touch with your mortgage provider to check what rules they have around overpaying on your mortgage.
When you get a mortgage, you have to pay several fees and charges. The amount you pay depends on several factors, 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.
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've paid off the full amount you borrowed. Mortgage terms normally last for 25 to 35 years. And once it’s all been fully paid off, you 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 aren't making a dent on the total amount you borrowed. At the end of the mortgage term, you still have to pay back the total balance of money you borrowed. Once you’ve done that, you own your property outright.
Having an interest-only mortgage means your payments tend to be lower than a repayment mortgage. But if you’re looking at interest-only rates, make sure you know the financial implications.
As the name implies a first-time buyer is usually defined as someone who buys a residential property and has never owned one before. This includes properties in shared ownership.
Yes, you can get a mortgage with bad credit, but you might find your options are a bit more limited.
What you're likely to find is that the pool of lenders willing to let you borrow is smaller than someone who has a good credit rating. And the ones that are available are likely to offer you higher interest rates and fees.
APRC means the Annual Percentage Rate of Change.
Most mortgage deals have 2 different APRs when you first apply - an introductory rate and an SVR. This means it can be difficult to work out which overall deal is better for you.
The APRC takes this into account. Assuming your introductory APR lasts for X years and the SVR doesn't change, it calculates an overall, single percentage. This lets you compare mortgage deals easily.
For example, it could be that one morgage has a lower introductory rate but a higher SVR. This might make it less of a good deal compared to one with a higher initial rate but a lower SVR.
An agreement in principle is an indication from a bank or building society that they could lend you a certain amount towards a property.
This gives you a rough idea of what kind of property you can afford to buy.
You're not committing to anything with an agreement in principle. But that also means you're not guaranteed to get that amount when it comes to applying for the mortgage.
What our expert says
There’s no reason why you shouldn’t compare mortgages like you would car or home insurance, and with the recent interest rate rises, exploring your options has never been more important.
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