Buying a house will most likely be the most expensive single purchase you ever make. Affording a home, especially in an expensive area like London, requires financial dedication, and choosing the right home requires extensive research and a strong constitution. Choosing the right mortgage for your financial situation is an intrinsic part of the house-buying process (unless you are lucky enough to be able to afford your home outright), and can be extremely daunting. For example, what is LTV? What is an agreement in principle? And a telegraphic transfer fee?
This guide aims to dispel the myths and explain everything you’ve ever wanted to know about mortgages, so that you can find the right mortgage for you, and go on to purchase the house of your dreams… or at least get on the property ladder!
Saving for a deposit
The first stage in buying your first house is saving up as much as you can afford as a deposit (if you already own a home, the equity in your property can be used as a deposit). The size of your deposit (or equity) compared to the amount you will want to borrow will determine your loan-to-value (LTV) ratio – and this in turn will affect the mortgage rates you can obtain. As an example, if you’ve saved up a deposit of £30,000 and want to purchase a house costing £300,000, your LTV would be 90% (the amount of your mortgage divided by the value of the house).
It is generally the rule that the lower your LTV, the better rates and deals you will receive. This is because mortgage lenders will perceive you as a lower risk, or at least there will be more than enough equity in the property to cover the amount you wish to borrow. So, saving a bigger deposit helps you on two fronts: not only will you receive better rates, but you will also need to borrow less, or borrow the same and get a bigger/more expensive property.
If, for whatever reason, you cannot raise a deposit, but are confident that your finances are such that you will be able to afford a mortgage, there are mortgages that offer 100% of the value of the home. However, these are rare, and where they do exist, they can often include other charges, such as completion fees or higher lending charges. Be sure to check out all the associated fees with any mortgage deal before you apply.
Give yourself the best chance of success
Following the legislative tightening of mortgage affordability assessments (notably with the Mortgage Market Review in 2014, and later in 2017), it is a lot harder to get a mortgage today. With any application, lenders have to be able to prove that borrowers will not only be able to afford their mortgage repayments, but will be able to ‘weather the storm’ if the Bank of England base rate were to increase dramatically. It is therefore important that you appear to be financially healthy when you apply for a mortgage.
With this in mind, it is prudent to check before you apply for a mortgage that everything in your credit history is correct, and your credit rating (and that of any partner or spouse with whom you are purchasing) is as glowing as it can be.
Your credit history and score can be obtained by any one of the three credit reference agencies (Callcredit, Experian or Equifax). Without knowing which agency or agencies your lender will use to assess you, you should check all three. If you find any anomalies, you should inform the agency immediately and ask that they amend your records.
If you find that you or your partner’s credit score is below par, you should take steps to improve it before you apply for a mortgage, as any failed applications can further damage both of your credit scores – and of course you won’t get the mortgage you wanted, or at best you will be offered a mortgage with higher interest rates and fees. Steps you can take to improve your credit score can include ensuring that you appear on an electoral roll, that you are responsible for and successfully repay credit over a period of time (for example a utility bill), and overpay on any existing debts. All of this will go some way to demonstrate to lenders that you are a responsible borrower.
If you are saving up for a deposit, you may already be foregoing luxuries, such as nights out, takeaways, weekend city breaks – but if you’re serious about getting a mortgage and showing the lender that you can afford an interest rate hike, it really can be worthwhile to adopt a penny-pinching lifestyle before and during the mortgage application process.
Talk to a mortgage broker or adviser
If you are a first-time buyer, or you want advice or help selecting the best mortgage for you, procuring the services of a mortgage broker or adviser is a good place to start. You can of course gain mortgage advice from any high street bank or building society, but the deals they can offer are limited to their own mortgage products.
If you opt for an independent mortgage adviser or broker, they will be able to offer a much wider range of mortgages suitable for your financial situation. However, you should be aware that this is a service, and there could be fees involved – but you should be told at the start of the process and in writing, so you know what to expect.
Types of mortgages available
There is no ‘one size fits all’ with mortgages. Even if your range of mortgages is limited because of a low deposit, or because of a high LTV ratio, you still need to decide which of the deals works best for you in the short and long term. While the interest rates charged by lenders is obviously important when comparing mortgages, you should be aware of all the associated fees with any deal, as these can often wipe out any benefits that a low interest rate can appear to offer.
A more holistic approach would be to compare the annual percentage rate of charge (APRC) of any advertised mortgage deal. This rate is expressed as an annual percentage and is the total cost of the credit to the borrower, incorporating all fees and charges, and any standard rates after any special deal expires. The APRC is standardised across all lenders and price comparison sites, which makes comparing different mortgages much simpler and more transparent.
Fixed rate mortgage
A fixed rate mortgage allows you to pay a fixed interest rate for a specific period of time, typically between two and five years, though each lender and deal is different. The main benefit of a fixed rate mortgage is that you know exactly what your monthly repayments are going to be, making it easier to budget, without the worry of the Bank of England base rate rising. Of course the converse of this is also true: if the base rate falls, you will not benefit.
Fixed rate mortgages often come with an early repayment charge if you decide to remortgage or repay your mortgage within the fixed period.
Once the introductory rate has expired, your mortgage will more often than not revert to the lender’s tracker or standard variable rate (SVR), which will be subject to change with the wider interest rates. Ideally, you should be looking for a new mortgage deal two months before your current promotional period ends, so you’re ready to switch and don’t get hit by a higher rate of interest.
A tracker rate mortgage has a variable interest rate, which rises and falls in line with the Bank of England base rate, and is usually a percentage point or two above that rate. This type of mortgage can be more unpredictable in terms of knowing what you are going to pay every month than a fixed rate mortgage – but on the flip side, tracker mortgages usually offer some of the best interest rates on the market.
Tracker rate mortgages are only offered for a limited period of time (typically around two years), and like their fixed rate counterparts, when the introductory period ends, your interest rate will revert to the lender’s SVR.
Lifetime tracker mortgage
Also known as a ‘long term tracker’, a lifetime tracker rate is similar to a standard tracker rate, in that the interest rate is tied to the rise and fall of the Bank of England base rate. The difference with a lifetime tracker mortgage, as you may have surmised from its name, is that there’s no introductory period: it’s a tracker mortgage for the duration of the loan.
Lifetime trackers are rarely offered these days, and where they are found, they generally charge a minimum percentage above the base rate, regardless of how low the interest rates fall, and are often restricted in terms of the length of the mortgage (maximum 10 years for example).
Standard variable rate (SVR) mortgage
This type of mortgage is the lender’s default mortgage, meaning it is the mortgage rate you will revert to once any introductory offer has expired. As the name suggests, the rate is variable and is loosely connected to the rise and fall of the Bank of England base rate. The main difference with a standard variable rate is that the interest rate charged is completely at the discretion of the lender and can be altered at any time.
Discounted mortgages start with the lender’s SVR and then apply a discount for a fixed period of time. For example, if a lender has an SVR of 5%, and the discount is 3%, then your interest rate would be 2%.
Importantly, if the lender’s standard variable rate increases – in line with a Bank of England base rate hike, for example – so does the discounted rate.
Like most mortgages with an introductory period, some overpayments are usually permitted with discounted mortgages, but there is often an early repayment penalty if you change mortgage providers or repay your mortgage before the end of the fixed term.
Capped interest rate
Capped interest rate mortgages are simply variable rate mortgages with a cap or ceiling on the interest rates you will have to pay. These mortgages are only offered for a fixed period of time (typically between two and five years), but do offer the security that your payments will never exceed a certain level. You can also benefit from any fall in interest rates. These perks come at a price though: the interest rate will usually be higher than a competitive tracker or discounted mortgage. Once the introductory period ends, your mortgage will revert to the lender’s SVR.
With an offset mortgage, you will have the opportunity to use any in-credit balances or savings to reduce (or ‘offset’) the amount of interest you pay on your mortgage. For example, if you have a mortgage of £350,000 and you have £50,000 in a linked savings account, you would only pay mortgage interest on the remaining £300,000. You can gain access to the money in your linked savings account, but you will lose the amount you can offset against your mortgage. For example, with the same mortgage of £350,000, if you took out £10,000 out of your savings account, you would have to pay interest on the remaining £340,000.
Many lenders will allow you to link multiple accounts to your mortgage, including current accounts, savings accounts and ISAs, which will help to maximise the benefit if you are always in credit. You won’t earn any interest on your savings, but you also won’t pay any tax.
Offset mortgages come in ‘fixed’ or ‘tracker’ rates, and can be especially beneficial if you can keep a large amount of money in a savings account (which must be with the same provider as your mortgage lender), as it can help to reduce your monthly mortgage payments, or help you pay off your mortgage quicker (because you can opt for a shorter term).
With an interest only mortgage, your repayments only pay off the interest on the mortgage, leaving the principal debt to be paid at the end of the term by other means (such as an inheritance windfall, or a savings or pension pot). The monthly cost of an interest only mortgage is obviously much lower – but because you don’t pay off any of the underlying debt, the total cost will be higher because you will be paying interest on the full loan throughout the mortgage term.
Interest only mortgages are rarely offered by lenders, because historical evidence has shown that investments such as endowment policies did not perform well and often fell short of the amount needed to pay off the remaining capital. Where lenders will consider an interest only mortgage, they will often require a cast-iron plan of how you are going to repay the capital, and may well check on your plan occasionally to ensure that it is still on track to meet the entire capital amount.
A flexible mortgage allows you a greater amount of leniency in regard to how much is repaid every month, including over and under payments, taking payment holidays, offsetting savings against your mortgage, borrowing back any overpayments, or moving to another provider without any penalties or charges.
Not all flexible mortgages offer all of these benefits, and many have minimum requirements (such as a minimum monthly payments), so it is important to check the details of each mortgage you are considering. There are often fees and charges levied when you take out a flexible mortgage, so you should weigh up whether the flexible nature of such a mortgage outweighs the cost.
A buy-to-let mortgage is specifically designed for landlords who wish to buy a property (or multiple properties) for rental purposes. Such mortgages work in much the same way as residential mortgages, in that the repayments can be fixed, tracker, or on an interest-only basis.
However, there are some fundamental differences with buy-to-let mortgages, notably that a larger deposit is required (typically a minimum of between 25%-30%), and most lenders will insist that the rental income is at least 125% of the mortgage repayments. Furthermore, the interest rates and fees payable on buy-to-let mortgages tend to be much higher, and the mortgages themselves are not regulated by the Financial Conduct Authority.
Help to Buy schemes
Help to Buy schemes were introduced by the government in an effort to help first time buyers gain access to the property ladder. There are currently three schemes available: Help to Buy: Shared Ownership, Help to Buy: Equity Loan, and the Help to Buy ISA.
Help to Buy: Shared Ownership
This scheme allows you to buy a share (between 25% and 75%) of a newly built property or a housing association property, and pay rent on the remaining share. You will need to take out a mortgage for your share of the property. If your financial situation improves, you can apply to increase your ownership of the property. In order to be eligible for this scheme your household income must not exceed £80,000 per year (£90,000 in London), and you must either be a first time buyer, an ex-homeowner, or an existing shared owner wanting to move.
Help to Buy: Equity Loan
This scheme allows you to fully purchase a newly built property with a government loan to aid with the cost and the deposit. Effectively, the government will lend you 20% of the cost of the home (up to 40% in London), and you only need to find a 5% deposit and a mortgage for the remaining funds. You will not have to pay interest on the government loan for five years. In order to be eligible for this scheme, your new home must cost no more than £600,000.
There are a broad range of fees that can be applied to any mortgage application, and they should be fully considered with each mortgage that you look at: some mortgages, which might look good at first glance, can have eye-watering fees that wipe out any gains that you might get from a low interest rate.
Mortgage fees can include one or a mixture of any of these:
A product fee, also known as an ‘application fee’, ‘arrangement fee’, a ‘booking fee’, or a ‘reservation fee’ is the money that is payable to the lender in order to secure a particular mortgage deal. Lenders can charge a combination of two of these fees (an arrangement fee and a booking fee for example), and can often disguise low rates with high fees. You should be careful to take into account all the fees chargeable for any deal you are considering.
On occasion, the lender will offer you the option of either paying some of these fees upfront, or adding them to your mortgage. The dilemma here is that if you pay upfront and there is a problem that blocks the purchase, your money is lost – yet if you add it to the mortgage, you will pay it back over your entire mortgage term. Adding it to your mortgage may help your cash flow in the short term, but you will pay back extra interest long term.
There isn’t an exact answer to this one, though there is one savvy strategy that you can try: add the product fee to the loan, and then overpay your mortgage by the exact amount (if permitted) as soon as the sale is completed.
Higher lending charge (HLC)
A higher lending charge – formerly known as a mortgage indemnity guarantee , or ‘MIG’ – is a charge that can be imposed by a lender if they consider you a higher risk, because the amount you are borrowing is a high percentage of the value of your property (a high LTV). Higher lending charges are usually limited to high LTV mortgages (80 to 95%), and not all lenders impose it. However, where it is charged, it can be as much as 8% of the loan, though there is usually the option of adding this charge to the mortgage. It should be remembered though, that if you add it to your mortgage, your loan to value ratio increases even further.
Telegraphic transfer fees
This fee is to pay for your mortgage lender to transfer the money to your solicitor in the form of a CHAPS payment.
If you have used the services of a mortgage broker, there will be fees involved. A mortgage broker can charge fees in several ways: a flat fee; an hourly rate (though here they should tell you what this rate is and what might affect the number of hours they spend on any application; or a commission-based fee, which will be a percentage of the amount you are borrowing. Any and all fees should be declared by the broker during your first conversation, and this should be in writing.
It is important to note that a house survey is different to a valuation. A valuation is exactly that: a cursory glance at a property in order to estimate its value. A survey, on the other hand, is an inspection of the property in order to ascertain the general and structural condition of the property. You should always ensure that the surveyor you choose is registered with the Royal Institute of Chartered Surveyors (RICS), as they adhere to professional standards and rules of conduct. There are generally three different levels of report to choose from, with the difference between them being the intensity of the survey:
- Home Condition Report: This is the most basic report and is usually only recommended for new or nearly new properties. This report will outline the general condition of the property (based on the visual condition only) including any urgent defects, and will highlight any potential legal issues. You can ask for a valuation of the property too (though there may be an extra fee).
- HomeBuyer Report (previously known as a Home Survey): This is a more comprehensive survey than a Home Condition Report, and will include all the aforementioned survey points, plus advice on any defects and any ongoing maintenance or repair costs.
- Building Survey (previously known as a Structural Survey): This is the most in-depth report and is usually recommended for older properties, or if the property you are buying has undergone major structural work, or you plan to do the same.
The cost of these surveys can differ wildly between surveyors, so it’s worth shopping around. Because a house is likely to be the most expensive single item you will ever purchase, it is likely worth taking out the most comprehensive report you can afford. Investing in a report at this stage could save you money and anguish in the future.
Lender’s legal fees
These are the fees that the lender incurs in the process of your mortgage application. The level of fees is set by the solicitor and will need to be paid up front. It is usually the case that these fees are added onto your own legal fees by your own solicitor. Some mortgage deals offer to waive these fees.
Legal fees (conveyancing)
When buying your home, you will need to employ a conveyancer or conveyancing solicitor to carry out the necessary legal work. The fees charged for this will need to be paid before your house purchase can be completed. Some mortgage deals offer to waive these legal fees.
Stamp duty is a tax payable on all land-based transactions. The rate of stamp duty you will be eligible for is dependent on several factors, including the cost of the house you are purchasing, whether you are a first-time buyer, and whether you are buying the house on a buy-to-let premise. Further to this, the rate and the actual name of the levy differs depending in which country you are buying the house. In England and Northern Ireland for example, the duty is known as ‘Stamp Duty Land Tax’, in Scotland it is known as ‘Land and Buildings Transaction Tax’, and in Wales it is simply ‘Land Transaction Tax’.
If you’re a first-time buyer in England and Northern Ireland, you are exempt from stamp duty on home purchases up to £300,000, and you pay a reduced rate of 5% up to £500,000. If your first home costs more than £500,000, you get no tax relief at all: you have to pay the full whack.
For more information on stamp duty and the rates, read our full stamp duty guide.
Your mortgage provider will need to value your property to ensure that it is worth the amount you wish to borrow (and thereby ensuring that they have enough of an asset to cover the mortgage if you default). Some lenders offer this valuation free of charge on certain mortgage deals, so it is worth checking and shopping around. It is important to note that a valuation made by a lender is in no way a survey: this should be taken out separately to check the condition of the property.
More mortgage fees
After you’ve got a mortgage, there are other fees that may become payable once you leave your lender, whether this is because you have fully paid off your mortgage, or whether you wish to move to a new lender for a better deal. These fees are not always due, and do not apply to every type of mortgage. For example, you may be subject to fees on a fixed rate deal until a specific date, but after that date, once you move to the lender’s standard variable rate, the fees no longer apply if you move or repay. Any of these fees and their associated rules will be cited on any offer letter from your lender. Be sure to read and understand the rules before you decide to switch or repay, to ensure that you won’t be penalised.
Early repayment charge (ERC)
This is a fee payable to your mortgage lender on certain mortgage deals (usually fixed, tracker, and discounted mortgages) if you:
- Pay off your mortgage before your current deal ends (whether this is by moving to another lender, or paying it off with a lump sum). This is sometimes waived if you move to another deal with the same provider, or you pay off your mortgage due to exceptional circumstances – for example, critical illness or death of spouse.
- Overpay your mortgage more than your overpayment limit.
Any early repayment charges will be set out in any offer letter you receive when you take out the mortgage – read and understand the rules before you switch to ensure that you won’t be penalised.
This fee is charged by some lenders when you fully repay your mortgage, even if you are not repaying it early. Any fees and exact amounts payable will be set out in any offer letter.
Applying for a mortgage
In order to find out if you are eligible for a mortgage, you can apply to a lender for an agreement in principle (AIP), which is also sometimes known as a ‘decision in principle’. This is a loose agreement stating that the lender will offer you a mortgage for a particular amount, based on some basic information about your income and expenditure and general financial and employment data. This isn’t a legally binding document, but can show buyers that you are likely to be accepted for a mortgage, which may go some way to strengthen your hand in the house-buying negotiation process. It is important to note that some lenders can offer such an agreement without leaving a mark on your credit file, which can be especially important if your credit score isn’t perfect.
Once you have chosen your perfect home and chosen your perfect mortgage (taking into account any restrictions, rates and fees), you will be in a position to make a formal application for a mortgage. This will require a more in-depth investigation, and you will be required to provide a great deal of paperwork. Every lender has different requirements, but be ready to submit such evidence as:
- Passport or driving licence as proof of ID
- Council tax statement if you have one
- Last three months of utility bills as proof of address
- Last six months bank statements
- Last three months of payslips as proof of income
- P60 form from your employer (showing any bonus income)
- Details of any other income you have, including any state benefits or pensions
- Proof of any deposits you have (and whether this is saved income or a gift)
- If you are on a fixed-term contract, a copy of your signed contract
- If you are self-employed, you will need details of your last two or three year’s HMRC tax calculations (SA302), signed accounts, or details of your accountant if applicable
And finally… don’t get complacent!
After working so hard to find a mortgage, you may be tempted to sit back, relax, and enjoy the fruits of your labours – but there is no time for complacency with a mortgage! Interest rates change, mortgage markets evolve, and your own personal circumstances may change in the future. If you are tied to a special deal for a fixed period, or are subject to early repayment charges, make a note to check the markets again once the time is up. If you are free to change your mortgage without penalties, you should ideally check out the latest deals on offer every year. You could save yourself a pretty penny – or even tens of thousands of pennies!
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