A beginners guide to mortgages
There are a number of major coming-of-age moments which we go experience as we march ever deeper into adult life, and all of them can be marked down as a right of passage of sorts. Learning to drive and getting your first car is a big deal, as is falling in love and having your heart broken for the first time. Moving out of your parent’s house is a huge step too, as is the day you graduate from university or bag your first real career break.
However while all of these landmark moments are significant, certainly one of the biggest commitments any of us will ever take, barring marriage and starting a family, is making the decision to buy a house. Stepping up onto the first rung of the property ladder will likely be the most significant purchase you’ve ever made, and undoubtedly the most expensive.
If at the time of reading this article you quite rightfully feel a little daunted and overwhelmed by the prospect of getting a mortgage, don’t worry – you’re not the first person to be terrified by the idea and you won’t be the last. Even those who are experienced in buying and selling homes often dread the idea of jumping through all the house-buying hoops they’ll have to leap through.
Who this guide is for
The title is a bit of a giveaway! If you’re an aspiring first-time homeowner, this guide will hopefully enable you to build up your knowledge and understanding of the key things you need to know as you set out to get a mortgage and buy a home.
- To get the keys to your new first home, this guide will be centred around helping you to do these three things:
- Sorting out your finances. You’ll need to prove to mortgage lenders that you’re attractive to lend to – mortgage lenders are risk averse, so they’ll want to be sure that you are a safe bet.
- Make sure that getting a mortgage is doable, in terms of raising a deposit and ensuring that monthly mortgage payments are affordable over the duration of your repayment term.
- Get a good deal. There are numerous different types of mortgage out there, and lots of different lenders to choose from – it’s in your interest to sign on the dotted line for a mortgage that’s right for you and your circumstances.
Admittedly you might be wondering why you’d need to bother reading a guide like this in the first place? It’s a perfectly reasonable question to ask because there are plenty of sources of house buying information out there.
For starters you’ll no doubt be able to call upon a lot of help and advice on getting a mortgage from friends and family members who have been there and done it themselves. Sure, this advice won’t be expert as such but it’s still worth listening to.
Also, like many other house buyers you may be planning to use a mortgage broker – a company which acts as a middleman, and will help broker a mortgage between you and a suitable mortgage lender. As industry specialists, mortgage brokers offer unbiased expert advice, and they also have access to information about a mortgage lenders credit and affordability criteria – in other words, they’ll know which lenders to place you with, and help to match you with the best deal available to you. And most importantly of all, mortgage brokers have a duty of care to their customers – if they offer bad advice and you end up with a mortgage which is a bad fit, or even unaffordable, you can complain and they’ll compensate you.
They are the safe option, unlike direct lenders or Financial Advisors who are tied to certain products, and who might give you advice which isn’t in their interest – for this reason, we’ll presume that you’ll be using one and not explore the other options.
So again, why bother with a guide like this one? The answer to this is simple: the more knowledge you have, the more empowered and confident a consumer you are. As with anything, knowing everything you need to know about the house buying process will enable you to understand how the process works. Any advice you are given you will understand, for the most part, and you’ll be able to ask the right questions and, at the end of it all, make an informed decision.
It’s you who has to sign on the dotted line to buy a house – you’ll be the one who is responsible for the decision you make.
Can I afford a mortgage?
As recently as the mid-noughties, getting a mortgage was easy – you only had to so much as turn up and apply for a mortgage lender to offer you a deal, unless your credit rating was absolutely and utterly beyond terrible. You could borrow pretty much whatever you wanted, and you could even get a mortgage worth over the value of your home if you wanted to get an additional cash sum on top of a home. However the Financial Crash and the credit crunch which followed changed everything.
Nowadays mortgage lenders expect house buyers to stump up a deposit of between 5-10% of the value of the home you want to buy before they’ll even consider your application. And even if you do have a sizable deposit, mortgage lenders will then subject you to all manner of background checks to assess whether they feel you are a safe bet to lend to. In other words it’s not like the old days – the government stepped in with the Help to Buy scheme to push lenders to open their wallets for good reason.
To determine whether getting a mortgage is right for you, the first thing you’ll need to do is look at the numbers. As with renting a home, getting a mortgage will eat up a large chunk of your monthly income so it’s important to do your sums and calculate exactly how much you can afford to spend each month – the key to doing this is to create a monthly budget, and compare your income against your outgoings.
Once you’ve done this and worked out how much you can afford to spend on mortgage payments each month, the next step is to do some homework and find out what size mortgage you can afford. By using this mortgage calculator here, you’ll get a good idea of what you can expect to pay for a mortgage each month. A good thing to remember here is that you’ll never be able to borrow more than 4-times your yearly salary if you’re single, and no more than 3-times your salary if you and your partner are looking to get a joint mortgage.
If after doing the sums you’ve found you have neither a deposit, nor the income to buy a home right now, don’t worry! If you can’t afford a mortgage now, you may well be able to in a few years if you’re careful with your money. Renting a home is no bad thing.
How big a deposit do I need? And what’s an LTV?!
As far as deposits go, size matters – the days of being able to get a mortgage without one are a thing of the past.
As much as this is a pain, the reasons for needing one makes sense. Having a deposit shows to mortgage lenders that you are in good financial health, and are disciplined enough to manage your money – this makes you a safer bet in their eyes than somebody who doesn’t.
As a rule, you’ll need to raise a minimum of a 5% deposit before mortgage lenders will give you the time of day. However while a 5% deposit will open the door, ideally you’ll need a 10-20% before mortgage lenders will start to offer you good interest rates on your mortgage – the rule is the more deposit you can put forward, the lower your rates and the less you’ll pay each month over the duration of the repayment term.
This begins to make sense a bit more when you look at loan-to-value rations, or LTV’s – this is the percentage of the house price you’ll be loaned as a mortgage, and the term mortgage lenders use to indicate how big a deposit you’ll need. It works like this: if you put forward a 5% deposit on a £100,000 home, you’ll have to take out a mortgage for the value of 95% of this amount, which equates to £95,000 – this means the LTV will be 95%
However if you can afford to, or are expected to put forward a 25% deposit on a £100,000 property, the LTV will be 75% – in other words you’ll be loaned 75% of the value of the property, or £75,000, in the form of a mortgage.
To help aspiring homeowners raise the money they need for a deposit, the government has setup a Help to Buy ISA, and a Help to Buy deposit scheme which aims to help those who are struggling to raise a deposit – just follow the links to find out more about these government initiatives.
Boost your chances of getting a mortgage by getting your credit score up to spec
As we mentioned before, however, it’ll take more than a deposit for a mortgage lender to accept your mortgage application. Unlike during the golden days in the mid-noughties, when lenders would throw mortgages around like confetti, now, they want to be 100% certain that you’ll repay what you owe without getting into trouble – be prepared to face numerous affordability checks and a credit checks, in other words.
While each mortgage lender will have their own affordability criteria which you’ll have to meet, the general rule is that you’ll need a whiter-than-white credit rating – that means no defaults, CCJ’s or even missed payments, ideally. If you have any black marks and blemishes like these on your credit file, and if your finances are in a bit of a mess, you’ll need to spend some tidying up and boosting your credit score.
Credit scoring is a very black and white business. This means that while it might take time to fix your credit rating, if you’re in debt and in a financial mess, over time you can and will build a good credit score if you get the basics right.
For starters, get on the electoral register – this will give you a credit score an immediate boost. Once you’ve done this, the next step is to check your credit file so that you can assess your current credit score and the state of your financial health – this can be done easily and for free by signing up to a free membership deal with the likes of Experian, Callcredit, Equifax or Noddle.
If after checking your credit file you notice you have any debts outstanding, it is essential that you work to settle them before taking on a mortgage. It’ll be virtually impossible to get a mortgage with defaults or CCJ’s to your name, so you’ll need to work to settle them first – to do this either set-up a debt repayment plan with your creditors yourself, or approach an organisation like StepChange or the Citizens Advice Bureau who will set up a payment plan on your behalf.
In fact before applying for a mortgage, ideally you’ll be free from credit card debt, any outstanding loan balances, and out of your overdraft. The key is to show mortgage lenders that you’re solvent, and there’s no better way of doing this than being debt free – the less debt you have, the more attractive an applicant you’ll be to mortgage lenders.
All in all, clear all of your debts, make sure that all credit repayments are on-time, and avoid behaviour which might be perceived negatively by a lender – withdrawing cash on a credit card and taking out payday loans are perfect examples of financial actions which will be held against you.
What are the different types of mortgage repayment options available to me?
While there are various different types of mortgage options for you to choose from, which can make the whole process seem a little bewildering to the untrained eye, it’s important to remember that a mortgage is a loan. Nothing more, nothing less.
- The two things to remember, however, are that:
- Your mortgage will take a long time to repay, meaning that even if you get a low mortgage rate, you’ll still end up paying a lot in interest over a long-term period.
- Your mortgage is a ‘secured’ loan – it is secured against your home, meaning that if you get into trouble and can’t meet your monthly mortgage repayments, your mortgage has the right to repossess your home and still. What makes things worse is that if they do this and fail to recover all of the money that you owe, you’ll have to make up the difference.
This is why it’s so important to get a mortgage that’s affordable, and to pick the right mortgage package.
We’ll go into more detail below, but you’ll have the choice of taking out a repayment mortgage, which will see you repay the value of your new home plus interest, or an interest-only mortgage where you will pay only the interest payments each month… which is great, until you’re expected to foot the full bill for your home at the end of the mortgage-term. And then after you’ve chosen between these two options, then you need to choose whether to opt for a fixed-interest mortgage or a variable rate mortgage. Of which there are three kinds. Phew!
By weighing up the pros and cons of each option, and then combining them you can create a mortgage which is tailored to you, depending on what your circumstances are now at the time of reading, and where you think you’ll be a few years from now.
With this mortgage option your monthly repayments will factor in the cost of repaying the value of your home, plus interest.
Repayment mortgages are costlier than interest-only mortgages, but once your mortgage term is over your house belongs you to outright. During the early years in your mortgage term your monthly payments will mostly go towards repaying interest on your mortgage, but towards the end you’ll be mostly paying the debt for your house itself.
If you can afford to repay this type of mortgage over a shorter repayment-term, such as a 15-year term rather than a 25-year one, you’ll pay a good deal less in the long-run. However doing this will mean higher monthly repayments in the short-term.
The name is self-explanatory – with this type of mortgage you’ll only repay the value of the interest over the mortgage-term, although you’ll be expected to pay the value of the property in full once it has expired.
The chief benefits is that monthly repayments are cheaper when compared to a repayment mortgage. If you’re paying 5% interest on a £100,000 mortgage, this works out to £5,000 per year – that’s £417 per month. However you’ll have to either have to save-up enough to pay off the cost of the house in full at the end of the mortgage-term, by setting up and paying into an ISA, for example, or sell the property to cover the cost. Relying on the money raised by a house-sale to cover the cost is risky however because you’re relying on house prices being the same in future as they are now – this is far from guaranteed.
Fixed or variable?
Now that was the easy bit, what with interest-only mortgages being so risky. Here’s the trickier part – it’s time to decide whether to opt for a fixed-rate or variable-rate mortgage. Quite simply you’ll be deciding whether to play it safe and fix your monthly interest payments are gamble on the economy and go for a deal in which the rates will change in accordance with what the Bank of England does.
As the name suggests, fixed-rate mortgages are fixed. They are utterly unchanging, and will remain the same at the end of your mortgage-term as they were at the start, whatever happens to the Bank of England base rate, or any other rates anywhere. If you’re seeking unchanging safety and peace of mind, this is the option for you.
The good bit is this means that should instability in the British economy cause interest rates to rocket, your mortgage will be unaffected – bearing in mind that interest rates are at an all-time low, it is inevitable that they will rise at some stage. The down side is that should rates tumble – which for the same reason we mentioned a moment ago is highly unlikely – you won’t benefit from the reduced monthly interest payments that somebody with a variable-rate mortgage would.
It’s the safe option. An insurance policy, if you will, because your interest payments will never rise. However the downside is that your starting interest-rate will almost certainly be higher than it would be with a variable-rate mortgage.
Variable-rate mortgages, on the other hand, are a completely different kettle of fish. Their rates can, and undoubtedly will change, whether because of fluctuations in the performance of the wider British economy, or simply because your lender decides to change their rates – here’s a hint, changes to variable-rates only usually go one way, and it’s not down.
When the economy is growing, or even booming, and inflation is on the up, interest rates normally rise. Likewise when there’s a recession, they quickly fall. This means that while you will almost always get a lower variable-rate at the beginning of your mortgage-term, your rate will inevitably rise, and so too will your monthly interest payments accordingly. In other words your monthly mortgage payments will rise and fall – you’re gambling on the performance of the UK economy and the market, effectively.
- There are three types of variable rate mortgage:
- Standard Variable Rates (SVR’s)
- Discount rates
There is no right or wrong answer when it comes to whether to go fixed or variable – it all boils down to whether the anxiety of mortgage repayment fluctuations will keep you up at night, or whether you’re happy to gamble and see if the market smiles on you.
That said, if you feel you’ll be cutting it fine budget wise with your mortgage payments, and any increase in cost would hit you hard, it might be advisable to go fixed. As with gambling, you should only chance it with a variable-rate mortgage if you can afford to potentially pay more money each month.
Additional insurance products? Be aware this will be a hard sell.
Mortgage advisors use a tactic called ‘disturbance’ to sell associated insurance products, such as critical illness, life insurance, accident sickness and unemployment, etc, which will protect your mortgage payments in the event of death, illness or redundancy.
Mortgages generate little commission for advisors, so instead they earn bonuses through insurance product bolt-ons. That isn’t to say they aren’t worth considering – having certain insurance cover on your mortgage could save you from finding yourself in serious trouble, should some unexpected disaster strike during your mortgage-term. But be aware that while insurance cover is great, it will increase the cost of your monthly mortgage payments.
Beware mortgage fees…
It can be easy to get so carried away in the business of viewing houses and fretting about your application that you run the risk of forgetting about one very important thing: mortgage fees.
Before going through the application process and signing on the dotted line, you’d do well to stop and calculate what the full cost of fees will be, when added to your mortgage. They’ve risen substantially over the past 10-years or so, and they could easily add around £3,000 to your mortgage bill, if not more. There’s no getting out of paying them, but the good news is that you can take steps to take the sting out of them by minimising the cost – this is something that a good mortgage broker will help you with.
Here’s a look at the key fees that you’ll be confronted with – as a note of caution, be aware that different lenders may give different names to them, which can make it harder to compare which lenders are offering what.
Arrangement or completion fee
Quite simply, an Arrangement Fee is an admin charge which mortgage lenders will charge you for setting up a mortgage. Barring stamp duty, potentially, the arrangement fee will be the largest you’ll have to pay. While what you can expect to pay varies massively, depending on whether your agreement fee is a cash amount or a percentage of your mortgage, don’t be shocked if it comes in at £2,000 or more.
You’ll have the option to either pay the Arrangement Fee upfront, or bolt it on to your mortgage. Both of these options have their pros and cons: paying upfront means that no interest is added, unlike when it is bolted onto your mortgage. This means that it works out a lot cheaper in the long-run.
However the downside is that, firstly, by paying upfront you’ll have to raise more money upfront – raising thousands for a deposit and the Arrangement fee might be too big an ask for your finances if you haven’t got a larger budget. Furthermore, by paying the fee upfront you run the risk of losing it your mortgage application is declined or the purchase falls through. This is not uncommon
Booking or reservation fee
Some lenders will charge a reservation fee, so that they can secure a good offer on a fixed-rate, tracker, or discount deal for you.
At up to £200 it isn’t too expensive, but you will always have to pay the fee upfront. It’s worth noting that it is non-refundable as a rule.
Valuation fee + special rule in Scotland
This is the fee that a mortgage lender will charge you for commissioning a mortgage valuation – a basic inspection of your home which will tell a lender whether your home is suitable security for the mortgage they are about to give you. They want to know that if your home is repossessed, that they can sell your home at a good enough price to get their money back.
The cost of this charge will vary, depending on the valuation of your soon-to-be home, but expect to pay in the region of £250. As a sidenote, it might be worth investing in a homebuyers or full-structural survey too – this will help identify and damp or structural problems, although you’ll have to pay up to £700 for this. It is money well spent, however.
Legal fees or conveyancing charges
These are paid to your solicitor to cover the cost of all the legal stuff that comes with buying a home. You won’t have to pay this charge until after you’ve signed on the dotted line for your mortgage, although it’s difficult to say exactly how much you’ll end up paying. There are various factors to consider.
What you end up paying will depend on which solicitor/conveyancer you used, and whether your property is a freehold or leasehold property. You’re likely looking at costs of up to £1,000, just for the sake of offering a ballpark figure.
Depending on the value of your future home, stamp duty will range from costing you nothing, if it’s a low-cost property, to a small fortune if you’re getting a mortgage on a high-value one.
If your property is valued under £125,000 in England, Wales or N. Ireland, or £145,000 in Scotland, you’ll pay nothing. However properties valued over this amount will see you pay successively more, depending on which stamp duty price band they fall into.
To find out what you’ll liable to pay in Stamp Duty for your house buying budget, you can use this Stamp Duty calculator to do your sums.
Final thoughts: best of luck, and do further homework on mortgages before applying
You’ve reached the end of our guide – thanks for your patience! Although this guide should cover the key points, with regards to getting a mortgage, and ensure that you have an adequate understanding of what mortgages are all about, what you’ll need to pay for, and what you’re likely going to have to pay for what, we still advise that you do further homework. You can never know too much, especially because of the huge sums of money involved with house buying.
Best of luck!
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