If you’re looking to buy a home, you’ll most likely need a mortgage to purchase the property. The best mortgages will have a combination of low interest rates and minimal (or no) fees. Explore our guide to learn about how mortgages work, how much deposit you need and compare the best mortgage deals available.
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A mortgage is a secured loan made by a lender to help you buy a home.
In most cases, you stump up a deposit of at least 5% of the property price and a mortgage lender (usually a bank or building society) lends you the rest. You pay back the loan (plus interest) over a period of time known as the mortgage term. The typical mortgage term in the UK is 25 years.
There are a few deposit-free mortgages available, although not as many as there were a few years ago. You are likely to need a guarantor – someone who uses their savings or their own property as security for the mortgage – to back you with one of these loans.
The relationship between how much you borrow and your deposit is called the loan-to-value ratio, or LTV. If you buy a £200,000 house by putting down a deposit of £40,000 and taking out a mortgage of £160,000, you have a mortgage of 80% LTV – in other words, you have borrowed 80% of the cost of the house.
As a general rule, mortgages with lower LTVs charge lower interest rates. So a bigger deposit can mean that as well as having to borrow less in the first place, the cost of that borrowing is lower, too.
A mortgage is a loan secured against your property. This means the lender could repossess your home if you do not keep up with the monthly repayments.
Alternatively, the lender could force you to sell it to pay back what you owe. When you buy a home, you pay the seller the full amount, which is made up of your deposit and the money lent to you by the mortgage provider. The payment is made via your solicitor or conveyancer. You then pay back the mortgage (plus interest) in monthly instalments to the lender.
The mortgage term is the agreed time you have to pay it off: this is usually between 25 and 30 years.
The size of the monthly mortgage repayments is decided by two things: the mortgage term and the mortgage rate. If you pay off your mortgage over a shorter time, you will have to pay more in each monthly payment (although you will end up paying less overall because there will be less time for the interest charges to mount up).
The mortgage rate is the rate of interest charged on a mortgage by the lender - it is the cost of the loan.
The lower the mortgage rate, the smaller your monthly repayments. When you compare mortgages, the advertised mortgage rates are the annual amount of interest that you would be charged.
In general, when looking for the best mortgage deal, you are looking for the lowest mortgage rate.
Keep an eye on the fees, too, though. A mortgage that comes with a large arrangement fee can end up costing you more than a mortgage that has a slightly higher interest rate but low or zero fees.
Mortgages are divided into the following payment types:
With an interest-only mortgage you pay just the interest on the loan during the mortgage term. This means the monthly instalments are lower than with repayment mortgages, but the amount you owe the mortgage lender remains constant throughout the term of the loan. At the end of the mortgage term, you must repay the full amount that you originally borrowed (this is called the principal debt).
For example, if you have an interest-only mortgage of £300,000 at a rate of 2%, you are charged interest of £6,000 a year, which amounts to £500 a month. This is what you will pay your mortgage lender each month but your payments do not reduce the principal debt. At the end of the mortgage term, you will still owe £300,000.
In the meantime, you will need to plan for a way of repaying the principal debt at the end of the mortgage term, such as through savings, investments or an inheritance, or by selling the property.
With a repayment mortgage, your monthly payments cover the interest and some of the original loan. As your overall debt reduces during the mortgage term, so does the amount you are charged in interest each month.
This means that as you progress through the period of the loan, the proportion of your monthly payment used to pay off the amount you borrowed – the principal debt – increases, and the amount of interest you pay gradually goes down. Towards the end of the mortgage term, the bulk of your monthly payments goes towards shifting the actual debt.
At the end of the mortgage term, you have paid off the principal debt as well as the interest, and you do not owe anything to the lender. You own the property outright.
There are two main types of interest rate:
As the names suggest, the interest on a fixed-rate mortgages is fixed for a specified period, which is usually for 2, 3, 5 or 10 years.
Variable-rate mortgages have interest rates that lenders can change at their discretion. Usually (although not always), lenders change their rates when the Bank of England changes its base rate. This means that if the central bank cuts the cost of borrowing, the interest charged on your mortgage often falls. On the flip side, during times when the Bank of England is raising the base rate, mortgages tend to become more expensive.
The first thing you need to do is get a deposit. Some lenders will offer you a mortgage with a deposit of just 5% (95% LTV).
But remember that higher deposits usually mean you can access a more competitive range of mortgage options. The best mortgage rates are often reserved for borrowers with deposits of 15% or more. The more you can put down at the start, the more money you could save over the mortgage term.
It’s always good to have some savings you can access in case of emergency, and it’s unlikely you’ll want to forgo things such as holidays once you have bought your house, so keep some money aside if you can. Try not to overstretch yourself when you are working out what mortgage you can afford. But if you have a large balance languishing in a savings account paying little or no interest, you can consider putting that money to work by using it to increase your deposit and cut your mortgage payments.
Regardless of the size of the deposit, you will need to prove to the lender that you have regular income that covers the cost of the monthly mortgage payments, leaving you enough to live on. During the application process, the mortgage companies will want to know where your income will be coming from and what other commitments you have.
The lender will also want to make sure you would be able to cope with any interest rate rises during the mortgage term.
To compare mortgages and find the best deal, the first thing you need to do is answer a few basic questions.
Do you want the security of fixed monthly payments? If so, a fixed rate deal is the obvious choice.
Or would you prefer the lowest possible monthly payments? If that’s the case, an interest-only mortgage might be better – but remember that an interest-only mortgage will still need repaying in full at the end of the mortgage term.
Compare mortgage deals online, talk directly to a mortgage lender or speak to a mortgage broker.
Find out how much a mortgage lender is willing to lend to you based on your financial circumstances. This is called an agreement in principle (AIP).
Having an AIP is not the same thing as having a mortgage deal agreed, but it works like an estimate you might get from a tradesman or a mechanic. When you are looking to buy a property, having an AIP gives the seller the confidence to deal with you as it shows that you are likely to be able to secure the necessary funding to complete the purchase.
The process of remortgaging is similar to when taking out a first mortgage in terms of the paperwork and affordability checks made by the lender.
But instead of using your savings as a deposit, you can now use home equity. Home equity is the percentage of the property you own. Lenders are happy to use your home as collateral for the mortgage because they know that if there are problems further down the line, the value of your home will still be greater than the amount you owe. In the absolute worst-case scenario, and as a final resort, they will be able to recover their money by repossessing your home.
Repayment mortgages allow you to build up the equity in your property – the more of your original mortgage you have paid off, the more of the property you own, and it means you can opt for a deal with a lower LTV when you come to remortgage. That means you’ll qualify for lower interest rates.
Take a look at our best remortgage comparisons on our dedicated remortgage page.
For remortgage comparisons, see the table above.
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Last updated: 7 January, 2022