When buying a home, the majority of buyers are unable to afford it straight up. This is where a mortgage comes in. A mortgage is a special type of loan, as it is specifically tied to the home you are buying. There are many different types of mortgage lenders. This article will take a look at the most common type of mortgage that could help you buy a home.
How much can I borrow?
The most common lenders are high street banks and building societies. The amount that your mortgage lender will agree to lend to you is mainly dependent on a multiple of your income. This is known as loan-to-income ratio, and in most cases is capped at four and a half times your income. For instance, if your income is £40,000, the most you could borrow from a mortgage lender would be £180,000. The lender must also assess what level of monthly payments you can afford, after taking living and personal expenses into account.
Your lender will also plan ahead and take into account the effect of certain situations which may affect your financial situation. For instance, a rise in interest rates, changes in your lifestyle that affect your expenditure, or redundancy. There are lots of mortgage calculators online which can give you an indication of how much you can borrow. If the mortgage available to you doesn't match the property value that you'd like, you might consider an additional loan product. This could be in the form of an equity loan such as Help To Buy Equity Loan or Proportunity Loan. You should research your options and must seek qualified financial advice. Buying a home is, after, a big financial decision.
All mortgage lenders will require some form of cash deposit. As a rule, you’ll need to save a minimum of 5% of the property value you are purchasing. This means if you are buying a £200,000 home, you’ll need at least £10,000 in savings. Plus, you'll need more to cover fees, legal costs, and any applicable stamp duty as part of the home purchase.
Mortgage repayment types
When it comes to repaying the loan, most mortgages fall into one of two main categories. There are several more types of mortgage, each with their own advantages and disadvantages but you can be sure in every case that you will be paying interest on the loan.
The first, and most common type, is a repayment mortgage. This is when you pay off the capital from the mortgage alongside the interest every month. In this context, capital refers to the amount of money you have borrowed. At the end of the agreed mortgage term, you will have paid back everything you have borrowed. The longer the mortgage term, the lower the monthly payments (and vice versa).
The second type is an interest-only mortgage. This means your monthly payment to the lender will only cover the interest owned on the loan amount. The amount of money you have borrowed stays the same. You may choose to make a repayment of the loan at a time that suits you, as long as it fits with the terms of the loan. Interest-only loans will often need more planning and discussion on when and how to make the final capital repayments.
At the end of the mortgage term, your mortgage lender will expect you to pay back what you owe. If you are unable to, your lender can force the sale of your home in order to get back the capital they are owed.
You should check the conditions before you agree to take out an interest-only mortgage.
What do I need to know about interest rates on my mortgage?
The interest you pay on your loan is essentially the cost of having the loan. The total amount of interest you pay depends on:
- loan amount
- loan duration (in this context, the mortgage term)
- interest rate
Interest rates are normally calculated as an annual percentage of the loan amount.
If Padma borrows £30,000 at an interest rate of 10%, her yearly interest would be £3000. Dividing this by 12 months gives her a monthly interest payment of £250 in the first year.
If the loan is a repayment loan, she'll be paying a monthly interest of £250 over the first year, plus a payment towards the capital. This is based on £30,000 divided by the mortgage term (length) in months where the total of interest, plus capital, is calculated as a fixed total monthly payment.
If the loan is an interest-only loan, she'll be paying just £250 per month and she can choose when to pay back the capital (but the longer she leaves it, the more interest she'll end up paying)
Interest rates can be fixed or variable. A fixed interest rate gives more security to the borrower, as they can make financial decisions based on knowing the amount of interest they'll be paying each month. Many mortgage providers offer an initial fixed interest rate as a "perk" for taking out a loan with them. After the fixed rate period ends, the loan reverts to a variable rate.
A variable interest rate (standard variable rate, or SVR) is a lender's reversion rate. Once the fixed interest period is up, the mortgage loan will switch to this rate. It can be worth checking the terms of your mortgage loan and changing provider if you find a better deal than your lender's SVR.
It all sounds a bit too complex
Mortgages can take a little time to understand, but it's the huge variety of products, providers and perks that makes the mortgage market bewildering to many.
Speaking with a qualified mortgage adviser (also known as a mortgage broker) can help you understand which product is right for you. They will offer advice and be able to sift through the deals, having access to deals that aren't available direct to individuals.
They can clarify the cost of each product, including interest rates and fees, and recommend the product that will suit your circumstances - taking into account your credit rating, employment history and personal situation. It can save time and money, knowing that your financial future is in the hands of a qualified professional.
Always ensure that the broker you choose is a registered broker. By signing up to an account with Proportunity, you will have the chance to be connected with one of our tried and tested brokers, but friends and family may also be able to recommend one to you.