A Beginners Guide to Mortgages in the UK

New to learning about mortgages in the UK? Owning property can be simple and straightforward. However, in most cases, the would-be homeowner won’t have the money needed to purchase that property outright. And even those that do have the cash on hand at that instant would rather have their payments stretched over a period of time to better manage their finances.

So what option do you have to get the funding you need and purchase that property. The answer comes in the form of the mortgage. And in this beginners guide to mortgages, you shall be guided through the different aspects of a mortgage, the systems you have to follow, and how to manage the requirements that the contract demands from you.

Chapter 1. What is a Mortgage?

As intimidating as the term might sound, a mortgage is simply a loan. More specifically, it is a loan given to any person for the purpose of purchasing a property.

The concept of the mortgage is rather quite simple. In fact, it rarely differs from any other loan you would have to apply in any financial institution.

To start things off, you borrow money from the lender. There are some considerations you will have to meet first before you can get the full amount. Most institutions would ask a deposit of the property’s total value before you are given the full amount of the mortgage. The percentage depends on the policies of the lender and their assessment of the application.

Securing the Mortgage

Once you have the mortgage, it is expected that you will use that money to purchase the property or, at the very least, most of it. Whatever the case, you will then have to pay that amount of the mortgage over a period of time.

Of course, there are penalties to incur if you are unable to pay your obligations in time. Also, an interest will be fixed by the institution over your loan. After all, they have to earn in some way for letting you borrow money from them.

Also, although you will be living in the property, the lender technically owns the property. You will only become its full owners with no strings attached once the loan has been repaid in full.

Chapter 2: Kinds of Mortgage

Just like any other loan, there is more than one form of mortgage. In fact, there are more or less 16 different type of mortgages available in different countries right now.

But, for the sake of simplicity, let us look at the ones currently being offered by banks and lenders across the United Kingdom.

Fixed Rate Mortgage

As the name implies, the rate you will have to pay for this kind of mortgage stays the same throughout the duration of your contract. No matter what happens to the market be it changes in interest rates or even upheavals in the economy, your rate will always be the same from the first payment to the last.

One major advantage with this kind of mortgage is convenience. Since rates are fixed, you don’t have to deal with complex calculations as to how much you should pay for the next billing cycle. At best, this could help you in budgeting your monthly expenses.

The downside, however, is that fixed rates are usually higher than other mortgage rates. If you would think about it, a fixed rate plan allows the lender to earn more from their loan to you through the higher interest rate.

Also, if the interest rates fall below the fixed rate of your mortgage, lendees cannot benefit from it.

Variable Rate Mortgage

These mortgages feature a more fluid interest system in the sense that rates can change from time to time, unlike fixed rate mortgages, the rates here are generally lower and more manageable. However, there are certain aspects with this mortgage that you have to be careful with.

The Variable Rate Mortgage is further classified into 3 other mortgage types. They are as follows:

A. Standard Variable Rate

Known also as the SVR mortgage, this is the conventional variable mortgage with a rate that changes with the rise and fall of the lender’s base rate.

A major advantage with this kind of mortgage is the degree of freedom that it offers. You can overpay your loan and leave at any time depending on what you prefer.

However, that level of freedom also brings with it some degree of unpredictability. Your rate can be changed at any time throughout the duration of the loan. Worse, such changes can be implemented with short notice or none at all.

B. Discount Mortgage

This is a limited-period rate mortgage which applies for typically the first 2 to 3 years of your contract. The one thing that makes this mortgage type unique is that most lenders have their own program for discounts.

For instance, a bank might offer a 2% discount of your standard variable rate mortgage of 6%. This means that you only have to pay for the 4% for the first few years. Another bank might offer 1.5% discount of your SVR at 7%, meaning you’d have to pay for the remaining 5.5 for 3 years.

Pros and Cons

The benefit that this type of mortgage offers it is asking price. The rate starts cheap which should give you ample breathing room with your monthly expenses. Also, if the lender cuts their SVR, you will have to pay less for the succeeding months.

The downside, again, is the unpredictability. With discount mortgages, the lender has the authority to raise their SVR at any time. This means that you may have to pay a lot every month even if such payments are at a technically discounted price.

Also, this type of mortgage is utterly dependent on the base rates set by the Bank of England. If they raise, the effects that the discount should bring to your monthly expenses would drastically lower.

C. Tracker Mortgage

This mortgage has a rather unique movement in the sense that it follows the trend of the base rate set by the Bank of England plus a few percentages up.

For example, if the base rate goes up by 1.0%, then your monthly rate would increase by the same amount.

Tracker mortgages have the shortest lifespans among loan types as they last no more than 5 years. However, there are lenders that do offer trackers that last throughout the duration of your plan or until you switch to another contract.

Pros and Cons

The biggest benefit with this kind of mortgage is its dependence on the base rate. If it falls by even a few decimals, so will your monthly payments which should help with your budget. However, that also means that your payments should increase with every increase in the base interest rate.

Also, there are banks that require you to pay early repayment charges if you want to switch to another contract before the deal ends. As such, most lenders with tracker mortgages opt to let the deal cover its entire lifespan to avoid additional financial burdens.

Capped Rate Mortgage

Like the SVR mortgage, rates in this type of mortgage move along the line of the lender’s standard variable rate. However, there is a cap (hence the name) which prevents that rate from going any further up.

And since the rate doesn’t go up beyond a certain point, you can at the very least predict how much you are going to pay every month given the trend that your rate is following. Also, capped rates are cheaper compared to SVRs.

The major disadvantage with this plan is that the cap is often set at a high level. This means that the rate can still be expensive for lendees, even compared to fixed rate mortgages. Also, as with other variable mortgages, the lender reserves the right to change the rate whenever they feel the need for it.

Offset Mortgage

The most variable mortgage in the UK right now, Offset mortgages work by linking your savings account to the mortgage. This way, you will only pay the interest on the difference.

In essence, this kind of mortgage automatically takes the amount you have to pay monthly from your savings. This means that you don’t have to worry about budgeting since the money is already taken from your account.

With this scheme, you will still have to repay your mortgage regularly. However, by taking directly from your savings account, this mortgage gives you a better chance of clearing your debts at the soonest possible time.

Chapter 3: How does Interest for Mortgages Work?

The interest that you will incur for your loan will be crucial. After all, that rate is going to determine how much you will have to pay on a regular basis until the mortgage has been repaid in full.

The amount of interest you will have to pay for on the mortgage is dependent on the type of mortgage you choose. For instance, if you go for a fixed rate mortgage, the interest you will pay stays the same throughout the duration of the contract.

If this fixed rate period ends, you will usually be transferred to the lender’s SVR. This is usually higher than any special rate you have been offered previously. Also, at this time, you will notice that the payments for your interest will increase,

A Caveat

On the flip side, if you choose a variable mortgage, the amount you will pay will fluctuate right through the early years. This is because the rates set by the Bank of England go up and down depending on certain external factors.

If the Bank of England raises the rate, the costs for loans become steeper for lenders which they would pass on to anyone who wishes to loan from them.

This is why it is recommended for starting homeowners to opt for the fixed rate system so as not to hassle themselves with fluctuating variable rates. This is something that you should consider as no base rate from the Bank of England ever stays the same for more than 4 months.

Chapter 4: Where to Mortgage

This may not be apparent to you but you can only get a mortgage from a bank or a similar financial organisation. The granting of mortgages and other loans is strictly regulated by laws which is why only a few types of businesses are qualified to offer such to would-be property owners.

The most direct way to apply for a mortgage is to go to any of the local banks in your area and choose from their range of mortgage plans. Most banks offer more than two types of mortgage plans to fit the needs of every would-be buyer.

Should You Go to a Broker?

Alternatively, you can seek the assistance of a mortgage broker or an independent financial adviser. They can compare different mortgage plans available in the market (even the ones not advertised by banks) and can even help you establish a relationship with lenders. Of course, they would be asking for a fee of the deal you will make with the bank as that is the only way they can profit from their services.

For beginners, it is recommended to take advice to avoid making financing mistakes in the future. Also, the mortgage market is quite competitive and dynamic that you’d rather seek the help of someone who has experience doing business in it.

Execution-Only Mortgage

However, that does not mean that you can’t get a mortgage without receiving advice. This is what is called as an Execution Only Mortgage which is a viable but extremely limited way of securing the funding you need.

If you choose to secure an EO mortgage plan, you are expected to be quite knowledgeable about the following:

• The different types of mortgage and their interest trends
• The type of property you want to purchase
• The amount of money you want to borrow and how long you want to pay for it.
• The type of interest and rate that you want to deal with for the duration of the contract.

Also, the agent of the lending institution will ask a series of questions to determine whether or not you have sought financial advice beforehand. This way, they can help you assess if the mortgage you are about to apply is compatible to your budget.

Concerns with EO Mortgages

You will have to confirm that you are fully aware of the responsibilities and consequences that arise out of you taking a mortgage without receiving prior advice and you are consenting to undergo the application process.

Your willingness to shoulder the burden of whatever mortgage you apply for is crucial. If you later find out that you can’t fulfill the terms of your EO mortgage plan, filing a complaint and requesting a remortgage will be quite difficult on your part.

Nevertheless, the lender will still initiate mandatory affordability checks on your finances and assess you on your ability to regularly pay for the interest if you go for the Execution-Only route. After all, their goal here is to earn from the loan and they’d rather make sure that they are not making a bad investment with you.

Chapter 5: The Application Process

Applying for a mortgage is a process that involves two steps. The first phase will be the usual fact finding wherein the lender determines if you are someone compatible with the different mortgage plans that they offer. The second stage will be a more extensive investigation into your finances to determine if you are someone trustworthy enough to be handed a considerable sum of money to.

Phase 1: Introduction and Preliminary Assessment

Typically, an agent of the lender will ask a series of questions to determine what kind of mortgage you are applying for and if this suits your needs. Also, they will be asking for the usual basic information like your name, age, and address.

At this point, they may start delving into your financial background but would not get too deep with it (that comes later). What is important in this phase is for the lender to determine how much money they would want you to borrow from them.

It is also at this point of the process where you will be introduced to the concept of mortgaging with the institution. The agent will usually introduce to you their different products and services as well as the fees and payment methods that they use with their clients.

Phase 2: Affordability Checks and Other Background Investigations

Once the pleasantries are disposed, you will then be given an application form you must fill up. Also, the lender might request that you present some documents in order for your application to be considered. This might include financial statements and even your medical records although the actual requirements will be different from lender to lender.

Once you have submitted all that was requested of you, the lender will then initiate the proper fact finding process which will include an affordability assessment. Here, the lender will take a look at your statements to get a rough figure of your average income. They may also would like to establish your spending patterns.

Stress Points

One key factor that lenders usually look out for are “stress” periods in your financial reports. This will be the stretches of time where your finances will be at their lowest while your expenditures are at their highest possible levels.

This is something that is unavoidable in most people as there will always be periods when a person finds their income to be inadequate to their expenses. However, what lenders are looking for are an applicant’s ability to quickly recover from these periods at the very least or maintain a bit of stability with their finances during these periods at most.

Your Credit Report Score

Lenders will also take a look at one of the most conclusive pieces of evidence regarding your finances: your credit report. If they get a hold of your report from your credit agency, they can get a clear view of your most recent financial performance.

Obviously, applicants with a favorable credit report rating will have fewer problems in getting their applications approved. Alternatively, if your credit report is less than ideal, you will find your application taking longer to be processed or rejected outright.

Another factor that lenders would like to determine is if your finances are able to adjust to the presence of a new obligation I.e. the monthly payments with interest. They would like to know that your ability to repay them does not diminish even if the interest rates rise, depending on your mortgage plan.

Phase 3: Approval and Acceptance

If you do pass all the checks of the lender, you will then be given a binding offer as well as documents explaining the terms of your mortgage. This will also initiate what is called as a “reflection period” where you get the chance to weigh in on the implications of the mortgage before signing the contract.

Lenders will usually give you a 7-day reflection period so you can make the best possible investment decision. During this period, the lender can’t change or withdraw their offer except if expressly allowed in the terms of the mortgage. Also, you have the right to waive this period to speed up your application.

Once the period is over and you have made your decision, all that is left to do is to sign the agreement. You will then receive the amount of the mortgage within a few days or weeks, depending on the lender.

Chapter 6: Deposits (and Why The Amount Matters)

Before you can get the full amount of the mortgage, you will have to pay for the deposit. This is to ensure that a chunk of your money actually goes to paying the property you would wish to purchase.

Depending on the lender, you might have to deposit a fixed amount or a percentage of the property’s total value. Also, the kind of mortgage you applied for will determine the amount you have to deposit.

Whatever the case, the amount you will deposit will affect your interest rate. The more of that total amount of the loan/property value you will pay right from the start, the lower your interest rate will be.

What’s an LTV?

You might hear of something called Loan to Value when applying for your mortgage. This might sound intimidating but how LTV works is actually quite easy. It is simply the amount you own outright contrasted to the amount that you secured through mortgage.

For instance, if you plan to purchase a property valued at £500,000 and you deposited £50,000 which is 10% of the total amount, the LTV is for the remaining amount would be 90%.

Thus, the mortgage you will have to apply for is for the coverage of that 90%. This, in turn, becomes the LTV of your mortgage.

Naturally, the interest rate of your mortgage decreases if that LTV is at a lower percentage. This is because the lender has to take a lesser risk since the amount you are asking for them is lower.

How LTV Works

Say, for example, that you already down-paid £150,000 which is 30% of £500,000, then the mortgage you will need is to cover 70% of the property’s price. This means that the LTV for your mortgage is lower as well as your interest rate.

In most cases, you will find cheaper interest rates if you can pay at least 40% of the total amount. This is regardless of the kind of mortgage you applied for and their interest rate computation scheme.

Tip: If this isn’t your first-time buying a home, you could use the equity in any of your current property towards paying the deposit of your new property. This way, you don’t have to spend a lot of time generating the funds to pay for the deposit.

One Important Note

However, this will only work if you have a clean title of ownership with that property. In layman’s terms, that means that that property has to have no outstanding obligation like overdue taxes or delinquent payments.

As such, before you even think about purchasing a new home, make sure that you start on a clean slate. Paying all your outstanding obligations will not only help in securing that deposit but will also prevent problems arising from your mortgage application.

In Conclusion

If you meet all the requirements of the lender and follow the application process properly, you should get the funding you need to purchase that new property.

Now, all that is left to do is to deal with all the obligations and interest that comes from securing that loan. This, in itself, will be a challenge that spans years to even decades.

And to fully deal with your obligations up until the last payment, there are a few aspects about financing and debt management that you also have to learn.