Most of us would like to own a property – which usually means having to take out a mortgage. Choosing the right mortgage can be confusing because there are so many lenders and so many different types of mortgage.
Your mortgage is likely to be one of the largest financial commitments of your life, so it’s important that you get the right one for you. This guide will help you choose the right mortgage and understand the mortgage process and what your financial and legal commitments mean.
1. Different types of mortgage
There are many types of mortgage. These are the main ones:
Fixed-rate mortgages
With a fixed-rate mortgage, the monthly interest rate (and therefore your monthly mortgage payment) will stay the same for a set period of time, usually two, three or five years.
This means you can confidently plan your budget for the whole period, because you’ll know in advance your monthly mortgage cost. However, if interest rates fall during the fixed-rate period, the amount you pay won’t change. So you may end up paying a higher rate of interest than if you had been on a variable-rate mortgage.
At the end of the fixed-rate period, your rate will usually change to the lender’s standard variable rate.
Discount-rate mortgages
Your payments are based on a discounted rate set at a certain level below a lender’s standard variable rate for a specific period, which means your payments may go up or down. For example, a 1% discount for 12 months off the lender’s standard variable rate of 5% would mean a rate of 4% for 12 months.
Your rate and payments could go up and down during the discounted period. Sometimes the discount is stepped, for example, a discount of 2% in the first year, then a discount of 1% in the second year. At the end of the discount period, your rate will usually change to the lender’s standard variable rate.
Tracker mortgages
On a tracker mortgage, your interest rate is usually directly linked to an external rate, such as the Bank of England base rate (‘Bank Rate’) for a set time. For example, your rate may be 1.5% above the Bank Rate for three years from your mortgage completion date. Your rate will reflect the external rate being tracked. This means that when the external rate falls, you will benefit from the rate reduction during the tracker period; but if the external rate rises, so will your rate. These changes also affect your monthly payment. Some products have a ‘floor’ – a level below which the interest rate cannot fall.
Offset mortgages
An offset mortgage means you can use your savings to reduce the interest charged on your mortgage, while still giving you access to the money in your savings account. It deducts your savings from your mortgage balance, so you only pay interest on the difference. There are also tax benefits if you are an income tax payer as you usually pay a higher rate of interest on the amount you borrow for a mortgage than you receive on your savings.
2. Specialist mortgages
For more specific purposes, you will need a specialist mortgage, especially if you’re looking for something more unusual like self-build and renovation, shared-ownership, buy-to-let or credit-repair mortgages.
Self-build Mortgages
Self-build projects require the lender to make funds available in stages as the house is being built – these can either be paid to you in arrears or in advance, depending on the lender. Some lenders will also lend to buy the land with outline planning permission. An advisor from Melton Mortgage Solutions will be able to search 90 lenders to find the right self-build mortgage for you.
Shared-ownership mortgages
Shared ownership is a great way to get onto the property ladder. Simply put, you buy a share in a property and rent the rest. As a guide, you can normally buy between 25% and 75% of the property. If you can afford it, you’ll be able to buy more of the property – this is called ‘staircasing’ – and increase your investment to full ownership. You can buy a newly built house or one that is being sold by a housing association. You’ll need to take out a mortgage from a lender who specialises in this type of loan to pay for your share of the purchase price.
Buy-to-let mortgages
When you buy property as an investment, you won’t be able to fund it with a normal residential mortgage. Instead, you’ll need a buy-to-let mortgage.
There are three types of buy-to-let mortgage:
Regulated buy-to-let, which is when you or a member of your family will at some stage be a tenant
Consumer buy-to-let, which is when you have lived in the property as your main residence or you inherit a property that was a main residence and then, due to a change of circumstances, you choose to let the property and will receive no other rental income
Business buy-to-let for purchasing property purely as a business transaction to generate income and capital growth.
Credit-repair mortgages
A credit-repair mortgage may be an option if you’ve missed a few credit card payments, are in a debt management plan, have any county court judgments or have a poor credit rating for any other reason.
3. Mortgage costs
You need to be aware of the costs connected to a mortgage. The following costs relate to buying your home, switching your mortgage without moving home and the ongoing administration of your mortgage.
Legal fees
If you’re buying your home, the fee paid to your solicitor covers all legal work involved in transferring the property ownership to you. This is called conveyancing. The fee will often be a percentage of the cost of the home you’re buying.
A local search is done to check for plans for building or development of the land near the property that may affect its value.
A bankruptcy search is carried out on you to ensure you’re not bankrupt and therefore unable by law to borrow. A separate fee is charged for each search.
Land Registry fees are paid to register you as the property’s new owner and to register your mortgage on the Land Registry’s Charges Register.
For remortgages, a fee is paid to your solicitor to act in removing the existing lender’s mortgage and adding your new mortgage to the Charges Register. Your solicitor will also carry out a local search and bankruptcy search (as above).
You pay your solicitor’s fees on completion of the mortgage and they must come from your own funds (fees for searches are usually paid upfront). Some mortgage products may offer help with legal fees.
Stamp duty
You will pay stamp duty land tax, a government tax, if the property value is over the government’s threshold. Stamp duty is paid on completion of the mortgage, normally as part of your solicitor’s overall bill. You don’t usually pay stamp duty when you remortgage your home.
Estate-agency fees
If you’re selling a property, you will usually appoint an estate agent. They may charge around 2% or a fixed price of the selling price and it’s normally agreed before you appoint them. Your solicitor normally pays the fee on your behalf after receiving the purchase money.
Mortgage application fee
Some lenders will charge a fee that is payable as part of the cost of the product. You pay this fee with your application and it’s generally non-refundable.
Mortgage completion fee
This is to cover the cost of the administration associated with assessing your application and setting up your mortgage account. It’s payable at legal completion and can be added to your loan.
Valuation fee
A basic mortgage valuation is an inspection by a valuer on the mortgage lender’s behalf to make sure the property is suitable security for the loan. The fee is based on the purchase price or estimated value.
Some mortgage products may offer a free mortgage valuation, but if you would like a more detailed report there will be an extra charge.
Higher lending charge (HLC)
Some lenders charge a HLC if you are borrowing a high percentage of the property’s valuation or purchase price. This is to give your lender additional security if you cannot pay your mortgage and your property is taken into possession and sold for less than you owe. The charge is normally made on borrowing that exceeds 75% of the valuation or purchase price, although some lenders will pay this on a customer’s behalf. The lender may use the charge to buy an insurance policy designed to protect them against loss in case you default on or stop repaying your mortgage.
The HLC is designed to protect the lender and does not protect you individually. You remain liable to pay all the money owing, including arrears, interest and any legal fees. The insurers will normally have the right to recover the amount from you. The HLC is a one-off charge. It will not be refunded if you pay off your mortgage early. If you exercise portability (moving the mortgage to another property) and take another mortgage, a further HLC may apply.
How is the interest on my mortgage calculated?
Most lenders charge interest on a daily basis on the total amount still owing (the ‘balance’) on the mortgage. As monthly repayments (and any overpayments) are made to the mortgage, they reduce the balance immediately and so the interest charged.
What is an annual percentage rate of charge (APRC)
The APRC is an industry-wide method of comparing interest rates and charges for credit between lenders, so that you can make an informed decision on the price of your mortgage.
It’s important to look at the APRC because it reflects the true cost of a mortgage over the long term. For example, some lenders may offer a good introductory rate but charge a higher-than-average standard variable mortgage interest rate at the end of it, which will increase the overall cost and therefore the APRC.
The APRC takes into account the costs of setting up the mortgage, the interest rate applied over the mortgage term and how that interest rate is charged (annually, monthly or daily).
A second APRC is included in the European Standardised Information Sheet (ESIS) as an illustration of the cost of the loan using a 20-year high interest rate to give borrowers an idea of the impact of a significant interest-rate rise.
Administration fees
Lenders have a general tariff of charges for services that are outside the basic administration of your mortgage account, together with a tariff of charges for mortgage customers in arrears. You will get a copy of these before you take out your mortgage.
Early-repayment charge (ERC)
You can repay your mortgage at any time during the term. Lenders will charge interest up to the date you repay your mortgage. Sometimes, if you repay your mortgage early, in full or in part, an additional charge may be made as the mortgage has not run its full term. This is called an early-repayment charge. It’s usually attached to a preferential interest rate. If you have a charge like this, it will be shown in mortgage product literature, your European Standardised Information Sheet (ESIS) and your mortgage offer.
4. Mortgage process
The buying process has the following steps:
Decision in principle
When you decide to buy a property, you may want to know how much you can borrow and whether or not you qualify for a mortgage. Your mortgage advisor will look at your income and commitments and tell you what you can borrow.
This decision in principle means your details will need to be verified when you apply for your mortgage, so your advisor may need more information. You will receive a European Standardised Information Sheet (ESIS), which gives you detailed information on the mortgage product selected.
Mortgage application
When you have found a suitable property and agreed a purchase price with the seller, your mortgage advisor will make a mortgage application on your behalf. The application form is used to assess your suitability for the mortgage. You will need to provide some supporting documents, so your details can be verified by independent sources, such as your employer (these are called ‘status enquiries’).
Valuation
A mortgage valuation is an inspection carried out by a valuer to make sure the property is suitable security for the loan. It’s carried out on every mortgage application and usually happens at the same time as status enquiries.
A Homebuyer’s Report is a more detailed alternative to a mortgage valuation. It gives you a deeper survey of the property’s condition.
A full building or structural survey is a thorough and complete property inspection. It tends to be done on older properties.
Mortgage offer
Once your lender has approved the mortgage, your lender will make you a mortgage offer. The offer will explain the exact terms and conditions of the mortgage contract between you and the lender. The offer is binding on the lender,. You will then have a reflection period of seven days to consider the offer. The reflection period does not affect how long your offer is valid and you can accept the offer at any time. You will also be given a European Standardised Information Sheet (ESIS). A copy of your offer will also be sent to your solicitor. The solicitor should have already started the legal process.
Legal process
Once you have received the offer, the legal documents can be completed. Your solicitor will draw up a legal contract for you and the seller to sign. The signing of the contracts is called exchange of contracts.
A deposit (the difference between the mortgage and the purchase price) is payable at this time. After exchange of contracts, you are legally committed to buy and the seller is legally committed to sell. You should make sure that your property is insured, as it is your responsibility. At this stage the completion date is agreed.
Completion
Completion is the point at which the mortgage deed is signed and executed and all its conditions come into effect. At this stage your solicitor sends a report to your lender requesting the money to be released for the purchase. This report is called a Certificate of Title and includes the date the solicitor requires the money to be sent.
This confirmation tells your lender that the property can safely be accepted as security for the loan. The lender can then arrange to send the money to the solicitor in time for completion and confirm to you the monthly mortgage payments.
5. Approving your mortgage
There are various factors that lenders consider when approving a mortgage application.
Affordability
Lenders take a responsible approach to lending to ensure you are not overstretching yourself. So they take into account your income as well as loans and other outgoings when considering how much you can borrow. They include all credit commitments, such as school fees and car loans, in the calculation.
Amount of deposit
Lenders will consider the loan amount you have applied for as a percentage of the purchase price or valuation figure (whichever is lower). This is known as the loan to value (LTV). The lower the LTV, the larger the deposit and the greater stake you will have in your home.
For example, a £75,000 mortgage on a house valued at £100,000 would mean an LTV of 75%. There is a limit that mortgage providers will lend. It depends on the LTV, repayment method (such as capital and interest, or interest only) and type of property. The limit can vary depending on market conditions.
Credit history
It’s important to lenders that you have conducted any current or previous credit agreements satisfactorily. Lenders will look at such things as your previous mortgage payment record; and payment of other credit cards, loans. They do this by carrying out a credit search using a credit-reference agency.
The credit search will highlight any county-court judgments, property repossessions and defaults, and credit agreements. The credit-reference agency will keep details of the search. If you apply for a mortgage jointly with another person, a financial association will be created between you at the credit-reference agency. It will continue to be taken into account in future credit searches for either or both of you (steps can be taken to break the financial association).
Employment status
Lenders need to ensure you are in stable employment and will look at your type of work; your length of employment; type of contract, such as permanent, fixed term, temporary and whether you have any employment gaps. Lenders may ask your employer for a reference when assessing your application.
6. Repaying your mortgage
What repayment options are available?
Most mortgages can be arranged over a period of 5 to 40 years, depending on your personal circumstances and the type of mortgage you choose.
There are two standard ways to repay a mortgage:
Capital-and-interest repayment
The monthly mortgage payment is made up partly of an amount to repay a proportion of the amount borrowed (capital) and partly of an amount to repay the interest.
Given that more capital is owed in the early years of the mortgage, the interest element of the monthly payment is higher than in later years.
As the mortgage term progresses and the capital owed begins to fall, the proportion of your monthly mortgage payment representing interest also falls. This means that as the term progresses on a capital-and-interest repayment mortgage, the amount you pay each month towards the capital becomes greater and the amount towards interest reduces.
If you make all the repayments, the loan will be repaid at the end of the term. We recommend you take out suitable insurance to ensure your mortgage is repaid in case you die during the mortgage term.
Interest-only mortgage
The monthly mortgage payment consists of an amount sufficient to pay only the interest due on the full amount of the loan (for the full term). You repay none of the capital owed. So at the end of the mortgage, you will still owe what you originally borrowed.
The capital element of the loan will normally be repaid at the end of the term using some kind of repayment strategy. You are responsible for ensuring that a repayment strategy is in place to repay the mortgage at the end of the term. You also need to ensure that you review any repayment strategy regularly to ensure it is on target to repay your mortgage at the end of the term.
You can also repay your mortgage using a combination of capital-and-interest and interest-only payments. This is called ‘part and part’.
Can I reduce or repay my mortgage early?
Yes, you can always reduce or repay your mortgage at any time. However, early repayment of all or part of a mortgage may have financial consequences depending on the mortgage product you take (see mortgage offer for details).
To enable a lender to offer a favourable interest-rate deal (such as fixed or discounted), it will sometimes apply a charge if the mortgage is paid off early. The charge will be a set amount or on a reducing scale depending on the product terms. This is called an early-repayment charge (ERC). If you don’t have an ERC on your mortgage, you can make overpayments and capital repayments without charge. An overpayment is an amount you pay in addition to your normal monthly repayment. If you overpay, you may find that, when interest rates change, your registered monthly repayment will change more than expected, as your overpayments will have been taken into account.
If you want to reduce your mortgage term, you will need to speak with your lender.
7. Other things to think about
Home insurance
Buying a home is a big commitment, so protecting your investment is a must. It is often a condition of your mortgage that you have buildings insurance in place and maintain it at a sufficient level throughout the mortgage term. If you are buying a leasehold property, the buildings insurance is normally covered in the lease.
Buildings insurance covers the bricks and mortar and such things as kitchen and bathroom fittings. Buildings insurance should start at exchange of contracts for house purchases because that is when you are legally committed to buying the property. We also recommend you take out contents insurance. It’s not compulsory, but not to protect your belongings is a big risk to take.
Life insurance and income protection
Life insurance is not an automatic feature of your mortgage, unless you have an endowment policy in place. If you have any other kind of mortgage, you should consider taking out life insurance to ensure your family is protected if you die.
Income protection is a longer-term insurance that is tied to your salary rather than your mortgage (for example critical illness cover, permanent health insurance). It does not cover unemployment but does cover inability to work due to illness. Many people consider what may happen to their family should they die but not what may happen if they could not work due to illness.
Can I take my mortgage with me when I move home?
Most mortgage loans are portable, which means that the terms and conditions of your current mortgage can be transferred to the mortgage on your new home. If there is an early-repayment charge on your existing mortgage, your new mortgage needs to be for at least the same amount as the old one to avoid paying a charge.
If you do borrow less, you only need to pay a proportion of the early-repayment charge. You still need to complete a mortgage application form because the mortgage is based on a new property. It is subject to your current status and valuation.
Borrowing extra on your mortgage
You may be able to borrow more money by taking out a further advance with your lender at a later date, subject to status and affordability. This is a further advance loan, which usually does not require a solicitor. Most people borrow extra money to do home improvements but sometimes you can borrow for other purposes.
Financial difficulties and changes in circumstances
Before buying a property or raising money on your home, it’s important to consider your income and outgoings to ensure you can afford your mortgage repayments now and in the future. It’s difficult to predict the future but you should look at mortgage repayments based on the standard variable mortgage interest rate and above to see what the impact would be. Lenders will give you an illustration of mortgage costs based on the standard variable mortgage interest rate when you apply for your mortgage.
You should also consider how you would pay your mortgage if you became ill or were made redundant. You can protect yourself and your family by taking out cover to pay your mortgage in the event of death, accident, illness and unemployment. If your circumstances change during the mortgage term, it may affect your ability to repay. If you do experience difficulties, it’s important to contact your lender as soon as possible.
For more information on what to do when you can’t pay your mortgage, please visit the Money Advice Service at www.moneyadviceservice.org.uk or call them on 0300 500 5000.
Financial Services Compensation Scheme (FSCS)
The FSCS provides protection if an authorised mortgage firm is unable to pay claims against it. The FSCS will only pay for financial loss incurred. The maximum level of compensation for claims against firms declared in default on or after 1 January 2010 is 100% of the first £50,000 loss, per person, per firm.
The cost of the scheme and compensation payments are funded by contributions from the businesses covered by the scheme. Information about the scheme is available on the FSCS website www.fscs.org.uk or telephone 0800 678 1100.
Jargon buster
Buying a property and moving home can be difficult enough even if you have done it before, so you don’t want to be confused by the language used during the process. Here’s our simple guide to the jargon.
Additional secured borrowing Sometimes called second-charge borrowing. This is where a lender offers a loan secured on the property which, if your property is sold, will be paid off after a first legal mortgage.
Annual percentage rate of charge (APRC) The APRC is a single rate that takes into account the costs of setting up the mortgage, the interest rate applied over the mortgage term and how that interest rate is charged (annually, monthly or daily).
Bank of England Base Rate (’Bank Rate’) This is the rate that is set on a monthly basis by the Bank of England’s monetary policy committee. It’s the rate the Bank charges for its borrowing.
Binding offer Your mortgage offer after the underwriting (detailed credit analysis) is complete.
Completion The point at which the mortgage money is released to remortgage your home or buy your new home. Your solicitor or conveyancer will ensure that ownership is transferred to you.
Consumer buy-to-let This is when you have lived in the property as your main residence or you inherit a property that was a main residence and then, due to a change in circumstances, you choose to let the property and receive no other rental income.
Disbursements The fees your solicitor has to pay others on your behalf, such as stamp duty land tax, Land Registry fees, search fees.
Electronic transfer This is the method by which your mortgage advance is paid to your conveyancer, solicitor or existing lender.
Equity The positive difference between the value of your property and the amount of any unpaid loans secured against it.
European Standardised Information Sheet (ESIS) This document must be provided to you by law and shows all the main information you need when choosing a mortgage. You can use it to compare mortgages from different lenders.
First legal mortgage Also known as a first-charge mortgage. This means the loan takes priority over any other borrowing secured on your property. If your property is sold, the first charge will be paid off first.
Foreign-currency lending Lending where, at the start of a new contract, a customer is not a UK resident or relies on income or assets that are not in sterling to repay the mortgage.
Lease A document that grants possession of a property for a fixed period of time and sets out the obligations of the landlord and tenant regarding such things as rent, repairs and insurance.
Loan Sometimes called the advance. This is the actual amount of money that your mortgage provider agrees to lend you.
Loan to value (LTV) This is the value of your loan as a proportion of your property’s value. For example, if you were buying a home for £100,000, and had a deposit of £15,000, you would need to borrow £85,000. This would mean you would require a mortgage product that offered an LTV of at least 85%.
Mortgage discharge fee (sometimes called a mortgage exit fee) A fee charged by the lender for releasing the legal charge over your property after you repay a mortgage.
Mortgagee The lender or institution that provides the funds for the mortgage.
Mortgagor The borrower taking out the mortgage.
Portable The process of transferring your current mortgage product to a new property when you move home on a ‘like for like’ basis. ‘Like for like’ means where your mortgage balance, mortgage term, mortgage repayment basis, loan-to-value ratio and mortgage type remain the same.
Redemption administration The process of removing the charge on your home after you fully repay the mortgage.
Reflection period This is a period of time that allows you to consider a mortgage offer. It does not affect how long your offer is valid for.
Repayment strategy This is your plan to pay off the capital on an interest-only mortgage when the mortgage term comes to an end. You need to check regularly with your mortgage provider to make sure your plan is still acceptable.
Retention If essential repairs are needed on a property, the lender may hold back some mortgage funds until the work has been completed. It will release these ‘retained funds’ when the work is finished.
Searches For example, enquiries made at the Land Registry, the Land Charges Register and local authorities to ensure there is nothing to cause concern about the property.
Subject to contract A provisional agreement made between buyer and seller, before exchange of contracts, which allows either side to back out without penalty (England and Wales only).
Term The length of time over which your mortgage loan is to be repaid.
Title The legal right to ownership of a property.
Title deeds The documents showing the ownership of property.
Transfer deed The legal document that transfers ownership of registered land.
Vendor/seller The person(s) selling the property.
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