Topic overview

Mortgages

Two people exchanging keys on signing mortgage agreement

A mortgage is usually the best option if you need to borrow money to buy a home or business premises. A wide range of lenders offer mortgages, and mortgage rates are generally lower than the interest rate for other kinds of borrowing.

But taking out a mortgage is a major financial decision. Make sure you understand the different options available and choose the right mortgage for your circumstances.

How mortgages work

A mortgage is a loan that is secured against property. That means that the lender may be able to sell the property to repay the mortgage if you fail to make payments or otherwise break the mortgage agreement. Because this security reduces the risk to the lender, mortgage rates can be very competitive.

The mortgage agreement sets out the details of what you are agreeing to when you borrow in this way. This includes:

  • the mortgage term – how long the mortgage lasts
  • how interest payments are worked out
  • how flexible the mortgage is – for example if you want to repay the mortgage early or switch to a better offer
  • what obligations you have for insuring and maintaining the property (to protect its value as security for the loan)
  • what restrictions there are on how you can use the property - for example, you might need the lender’s agreement if you want to let it out to a tenant

A typical mortgage for buying a residential property might last for 25 years. The mortgage might have a fixed rate for the first 2 to 5 years, and then switch to a variable rate linked to the Bank of England base rate.

With most mortgages, you make monthly payments that include both interest and a contribution to gradually repaying the mortgage. This means that you will no longer owe anything at the end of the term. Alternatively, an ‘interest-only’ mortgage means that monthly payments can be lower – but you are left still owing the full mortgage amount at the end of its term.

It’s essential to check the details, so that you can be sure that the mortgage matches your needs, and you understand exactly what you are agreeing.

Types of mortgage

Major lenders typically offer a whole selection of different mortgage options for buying a house or flat. For example, you can vary how long the mortgage lasts and how long any introductory fixed rate period is.

Other variations suit different situations:

  • more flexible mortgages, that allow you to make overpayments (to help pay the mortgage off early) without an extra charge, or ‘offset mortgages’ that let you use any money in your savings account to reduce the interest you pay
  • mortgages designed for special circumstances – for example, if you are buying a property to let it out (buy-to-let) or a shared ownership property from a housing association
  • guarantor mortgages for people who wouldn’t normally qualify for a mortgage, but where someone else (eg a parent) is prepared to take on some of the risk
  • mortgages that let you borrow against the value of a property that you already own – for example, an additional second mortgage, or equity release or lifetime mortgages for older property owners
  • commercial mortgages for business premises

How much can I borrow?

How large a mortgage you can get depends on a variety of factors, including:

  • how much you have saved to use as a deposit
  • how much you earn and how much spare income you have after taking account your normal spending
  • what your credit score is

Lenders will often only lend up to a set percentage of the property’s value – their maximum loan-to-value (LTV) – meaning that you need to cover the rest of the price.  Mortgages with an LTV as high as 95% are available.  Lenders also tend to limit amount they will lend to a maximum multiple of salary – perhaps 4 or 5 times.

The higher the LTV and multiple of salary you need, the fewer lenders you will find who are prepared to offer a mortgage. Interest rates will also tend to be higher.

For a commercial mortgage, the financial performance of your business will be a key factor. In many cases, the lender may also want the owners or directors of a company to give personal guarantees that they will make the payments if the company cannot. As with any kind of business borrowing, you should make sure you understand the risks before agreeing to give a guarantee.

Mortgage costs and affordability

Costs you should take into account include:

  • any initial fee mortgage arrangement fee (typically around £1,000)
  • the other costs of buying a home or business premises – including stamp duty, legal and survey fees, and removal costs
  • monthly interest payments and repayments of capital (for a repayment mortgage)

Regardless of how much a bank (or other lender) is prepared to offer, you should satisfy yourself that you will be able to afford the payments.  You can use an online mortgage calculator to get an estimate of how much you would have to pay each month. Bear in mind that monthly payments could go up – perhaps a lot – if the mortgage rate is variable and interest rates rise.

You may be eligible for government help, particularly f you are buying your first home or a shared ownership property.

Finding the best mortgage

Although you may turn to your existing bank first, it’s always worth shopping around to see what other offers are available. Comparison sites like comparethemarket.com and MoneySuperMarket can give you a good idea of what different lenders might be prepared to offer.

As well as approaching different banks and other lenders directly, you may want to use a mortgage broker to find the best deal for you. Many mortgage brokers are fee-free, and they may be able to get better offers than you could yourself. A mortgage broker can be particularly helpful if you have unusual needs – for example, if you have a poor credit score, are self-employed or old, or are looking for a high value or commercial mortgage.

You should look for a mortgage at an early stage so that you know what you can afford. You will be in a stronger position to negotiate a property purchase if you already have ‘agreement in principle’ from a lender that you can get the mortgage you need.

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