A Guide to Mortgages31st March 2020
For the majority of people who aren’t lucky enough to be sitting on a fortune, securing a mortgage is an essential part of buying a house. However, with so many factors involved, it can be a complicated, confusing and daunting process, especially if you’re about to take your first step on the property ladder.
A mortgage is a major decision that will shape your financial future for years to come, so it’s essential that you put plenty of time, thought and research into it. It’s always a good idea to seek expert advice before rushing into things. Finding the right mortgage can save you thousands of pounds in the long run.
But what is a mortgage exactly? What are the different types of mortgages? How much money can you borrow? And what do you need to do to get one? In this in-depth and easy-to-read guide, we’ll cover all the basics you need to know when it comes to mortgages.
What is a mortgage?
A mortgage is a specific loan used to buy property. In most cases, you pay back a small amount of the home loan plus interest each month until you either pay off the full amount or reach the end of your mortgage term (typically 25 years).
A mortgage is secured against your house, so if you fail to keep up with your monthly mortgage repayments, you risk losing possession of your home.
You can apply for a mortgage directly through a bank or building society. You can also use a mortgage broker, who will compare different mortgage products available on the market and help you find the best deal.
What are the different types of mortgages?
There are several types of mortgages available on the market, and they all work slightly differently. To decide which one is right for you, you must go through a step-by-step process and answer a few key questions. Which mortgage product you choose largely depends on your financial flexibility and your attitude towards risk.
First, you need to ask yourself: do you want a repayment mortgage or an interest-only mortgage?
- A repayment mortgage is where you pay back a small amount of your home loan plus interest each month. So long as you meet all your monthly payments, you’re guaranteed to have paid off the entire loan by the end of the mortgage term (typically 25 years). Repayment mortgages are by far the most common type of mortgage.
- An interest-only mortgage is where you only pay interest on your home loan each month (so none of the capital that you’ve borrowed). Instead, you must pay back the full amount in one go at the end of your mortgage term. This means that your monthly repayments will be lower. However, you’ll actually end up paying more in the long run as you’re paying interest on the full amount each month. It also carries a higher level of risk. Interest-only mortgages are usually only available on buy-to-let properties.
Next, you must decide how you want to pay your interest each month. You can choose between a fixed-rate mortgage or a variable-rate mortgage.
- A fixed-rate mortgage is where you pay the same amount of interest each month for a set period of time, typically two or five years. Fixed-rate mortgages are attractive because they offer security, control and peace of mind. You can budget each month knowing how much your mortgage repayments will be during this period. Fixed-rate mortgages are very popular — a recent Which? report found that 58% of 3,500 homeowners who were surveyed had fixed-rate mortgages.
When your fixed-rate period expires, you’ll most likely be placed onto your lender’s default standard variable rate (SVR), which has significantly higher interest rates that are no longer be fixed. Before you reach this point, it’s often a good idea to remortgage, which is where you swap your current mortgage for a better deal, either with the same lender or a different one.
- A variable-rate mortgage is where your interest payments change from month to month depending on how the economy is performing. If interest rates are down, your mortgage payments will be lower. However, if interest rates go up, so will your mortgage payments. Variable-rate mortgages can save you money, but obviously they’re more of a gamble.
There are three different types of variable-rate mortgages, including:
- Tracker mortgage — This is where the interest rate “tracks” an external rate, usually the Bank of England base rate, plus a set percentage. Often, a tracker mortgage will last for a set period (usually two or five years) before reverting to your lender’s standard variable rate. Or you can get a lifetime tracker mortgage where it follows a base rate for the entire duration of your mortgage term.
- Discount mortgage — This is where the interest rate follows an external rate, usually your lender’s standard variable rate, minus a set percentage. As with a tracker mortgage, you can get a discount mortgage that lasts for two or five years, or the full length of your mortgage term.
- Capped rate mortgage — This is where the interest rate follows your lender’s SVR, but it comes with an upper limit to how high your interest payments will go — usually for two or five years. You still benefit if interest rates drop, but if they rise, you can be sure that your interest payments won’t go above a certain amount. Capped rate mortgages tend to be more expensive as you’re paying for the added security. They’re also far less common that other types of variable-rate mortgages.
There are also other types of mortgages that factor in either your own savings or the savings of a close family member.
- Offset mortgage — Where you combine your savings and your mortgage to reduce (or offset) the amount of interest that you pay. Instead, you only pay interest on the difference. You still have to pay your mortgage each month, but your savings act as an overpayment which helps to pay off your mortgage early.
- Guarantor mortgage — Where a parent or close relative acts as a guarantor on your behalf. This usually involves them offering their own home or savings as security against your mortgage and agreeing to cover your mortgage repayments if you default. Having a guarantor improves your chances of being approved for a mortgage while giving you access to better interest rates and larger borrowing sums, but obviously it puts someone else at risk if you fail to keep up with your mortgage repayments.
There are also different mortgages based on the property that you’re buying. A commercial mortgage is a specialist mortgage used to buy business premises such as an office, shop or restaurant, while a buy-to-let mortgage is used by landlords to purchase a property that they intend to rent out to tenants.
How much money can you borrow with a mortgage?
How much money you can borrow depends on numerous factors. When deciding the size of mortgage to offer you, mortgage lenders will look at how much you typically earn in a month and compare it with your typical monthly outgoings. This is what’s known as a mortgage affordability assessment.
Here are the main factors that affect how much money you can borrow when looking to secure a mortgage:
- Income — This includes your basic salary plus any additional income you receive from a second job, freelancing, benefits, commission or bonuses. Most lenders will usually allow you to borrow between three and four-and-a-half times the total annual income of you and anyone else you’re buying with. For example, if your total household income is £50,000 a year, you might be offered between £150,000 and £225,000.
- Outgoings — Such as utility bills, council tax, groceries, transport costs, childcare payments and leisure activities. Lenders aren’t just interested in how much you spend each month, but what you spend each month. Some expenses are quite rigid while others are more flexible. For example, a gym membership can be more easily cut back than childcare payments.
- Deposit & loan-to-value ratio — Your loan-to-value (LTV) ratio plays a big role in how much you can borrow. LTV is the percentage of a property’s price that you’re borrowning versus how much you’re putting down yourself. If you have a 10% deposit, for example, your LTV will be 90%. The larger your deposit, the lower your LTV will be, and the more money you’ll be allowed to borrow.
- Stress test — Lenders will do a “stress test” on your financial situation to determine whether you’ll be able to cope if circumstances change, such as if interest rates rise, you retire or you go on maternity/paternity leave.
You can use a mortgage affordability calculator like this one here to figure out how much money you’ll be able to borrow.
What do you need to get a mortgage?
When applying for a mortgage, you need to provide your lender with a series of documents and paperwork so they can adequately assess the risk involved with lending to you. Essentially, they want to make sure that if they loan you this huge chunk of money, you’re able to pay it back.
Lenders will want to verify your identity, see evidence of your income and outgoings, as well as any existing debts, and check your credit history.
Having a good credit score will increase your chances of being approved for a mortgage while giving you access to better interest rates. Alternatively, a poor credit score will affect the quality of mortgage products you’ll be offered and may even scupper your chances of being approved altogether.
Here’s a list of the basic things you need when applying for a mortgage:
- Bank statements of your current account for the last three to six months
- The last three months’ payslips
- P60 form from your employer
- Proof of benefits received
- Utility bills
- Passport or driving license (to prove your identity)
- Statement of two to three years’ accounts from an accountant if you’re self-employed
- Tax return form SA302 if you have earnings from more than one source or are self-employed
If your application is successful, your lender will provide you with a “binding offer” and a mortgage illustration document(s) outlining the terms of your mortgage. You’ll also have a reflection period (typically seven days) in case you want to change your mind, although you can waive this if you want to speed up the process.
What fees are involved with getting a mortgage?
Much like most things in life, there are numerous fees involved with taking out a mortgage. The total cost of these depends on the mortgage product you’re applying for, the value of the property you’re looking to buy and your financial situation. But generally, you’re looking at least a few thousand pounds.
Here’s a general guideline of mortgage fees:
- Arrangement fee — £0 to £2,000. You can sometimes add this to your mortgage, but it will increase the amount of interest you pay
- Booking fee — £99 to £250
- Valuation fee — £150 to £1,500, depending on the value of the property
- Telegraphic transfer fee — £25 to £50
- Mortgage account fee — £100 to £300
- Mortgage broker fee (if you use a mortgage broker) — £500 or a commission
- Higher lending charge (if you have a small deposit) — 1.5% of the mortgage
- Buildings insurance fee — £25
If you’re remortgaging, you may face an early repayment charge or exit fee when backing out of your current mortgage arrangement. It’s always worth checking this before going ahead with a remortgage application.
Can you get a mortgage if you’re self-employed?
Simple answer: absolutely. Contrary to popular myth, self-employed individuals can get a mortgage just like everybody else, so long as you can prove to lenders that your income is reliable and you have good records of your earnings.
With more than five million people in the UK registering as self-employed — an all-time high — many mortgage lenders have become more comfortable lending to self-employed borrowers. They just require you to jump through a few extra hoops, that’s all.
In addition to the regular paperwork above (minus payslips from your employer, of course), self-employed applications need to provide a lender with the following documents:
- Two or more years’ worth of accounts from a qualified chartered accountant
- Two to three years’ worth of SA302 forms and a tax year overview from HMRC
- Evidence of dividend payments or retained profits (if you’re a company director)
- Evidence of regular and/or upcoming contracts/commissions (if you’re a contractor or freelancer)
How to improve your chances of getting a mortgage
Since the 2008 global economic crisis, mortgage lenders have tightened their restrictions when it comes to approving mortgages. As recently as April 2014, the Financial Conduct Authority (FCA) introduced a new law making it mandatory for lenders to conduct a full affordability check on mortgage applicants. This was done with the aim of preventing a repeat of the reckless mortgage lending behaviour that caused the 2008 financial crash.
While it may be slightly harder to get a mortgage today than it was 15 years ago, it’s certainly not impossible. In fact, there are various steps you can take to increase your chances of being approved for a mortgage — and the quality of mortgages you’ll be offered — whether that’s making drastic improvements or simply making a few small changes.
- Save for a bigger deposit
Putting down a larger deposit will make you a lower-risk applicant to mortgage lenders. It also means you’ll be offered more competitive interest rates. Most of the best deals on the market are reserved for buyers who can put down between 35% and 40% of a property’s value, while those with only a 5% or 10% deposit will have to pay a higher interest rate. For first-time buyers, there are various government schemes available to help you save for a deposit.
- Improve your credit score
Your credit rating is one of the biggest things mortgage lenders look at when reviewing your application. Building a good credit rating takes time and patience, but the best way to do this is by establishing a consistent record of paying back credit (whether that’s a credit card or a personal loan) on time and in full while avoiding running up debt. Keeping up with utility and phone bills also contributes positively to your credit score.
- Pay off any unsecured debts and close any unused accounts
Clear as much of your debt as possible and close down any accounts you no longer use. Otherwise, lenders may be concerned about your ability to keep up with your mortgage repayments.
- Make sure you’re on the electoral roll
Mortgage lenders use the electoral roll to verify your identity. Not being registered to vote is seen as a “bad” risk factor and may well lead to you being rejected. If you’re not sure whether you’re already on the electoral roll, check with your local council. If you’re not on it, you can register for free by signing up online or completing a registration form.
- Reduce your outgoings
Cutting back is always prudent, especially when it comes to getting a mortgage. Limiting your spending in the months leading up to your mortgage application will improve your financial health and make you a more appealing prospect to lenders. It will also positively impact your mortgage affordability, meaning you may even be able to borrow more money.
- Avoid applying for credit
It’s also smart to avoid applying for credit in the run up to applying for a mortgage. This is because everytime you apply for a loan, credit card or even a mobile phone contract, lenders will conduct a credit search that appears on your file. Having a lot of credit searches in a short space of time will make you look desperate to lenders and hurt your chances of getting the best mortgage.
What is remortgaging?
Remortgaging applies only to homeowners who already have a mortgage. It’s where you swap your current mortgage for a newer and better deal, either with the same lender or a different one.
Remortgaging is commonly used by people whose introductory deal (which usually lasts between two and five years) is about to expire and they don’t want to be placed on their lender’s more expensive standard variable rate. By switching to a new deal, remortgaging allows you to get a better interest rate and make significant savings.
Remortgaging can also be a useful option if you want more flexibility, such as being able to overpay your mortgage or take a mortgage holiday. Or if you want to borrow more money, either because you’re upsizing or consolidating your debts.
The question of whether or not you should remortgage requires careful thought and number-crunching. Because you’re “backing out” of your current deal, you may be hit with an exit fee or early repayment charge. So you need to do your sums and make sure that this cost is worth the long-term savings you could make. This is why it’s good to speak to a professional mortgage advisor.
How JonSimon Can Help You Get a Mortgage
At JonSimon Estate Agents, we’re here to guide you through the entire house-buying process. We can help you to not only purchase your dream home, but to secure a competitive mortgage you need to buy it.
With a network of trusted local contacts, we can put you in touch with an experienced, reliable and fully qualified mortgage broker who will discuss your financial situation with you in detail, compare the vast range of mortgage products available on the market and help you find the mortgage deal that’s right for you.
To find out how we can help you secure a mortgage, simply get in touch with your local JonSimon branch on the relevant phone number below. Our friendly property experts are more than happy to take your call!
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