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UK Mortgage Guide
A Basic UK Mortgage Guide - The Terminology And The Process
What is a Mortgage?
A mortgage is basically a loan that is secured on some form of property, be that your home, or your business premises. When I say secured, I mean in the event of you failing to keep up with your repayments (also known as defaulting), the institution is legally able to take ownership of your property (known as repossession) and remove you from it. Once they own the property they can then resell it, typically by auction, in order to get back the money owed. A mortgage is usually the largest single debt that an individual will possess in their lifetime. In the UK, mortgage agreements are normally taken out over a 25 year period, although there is flexibility to increase up to 40 years or down to 5-10 depending on the size of the loan.
The loan is paid back in monthly instalments which are designed to cover the interest charged during the month, and pay off an amount of the loan. Interest is charged at differing rates depending on the mortgage deal you sign up for, see types of mortgages below for more details.
When initially taking out a mortgage to purchase a property, most banks will require you to put down some form of deposit on the property, ensuring that they are not loaning you the full value of the property. This provides the banks with a cushion in the event that the property value reduces over the term of the mortgage. This allows them to protect themselves from having properties which are worth less than the outstanding loans on them. When people own properties in this scenario, this is known as negative equity. Typically, the larger the deposit you have, the lower the interest rate you will pay on the loan since the banks have more of a buffer in case of property value reductions.
The amount of the loan, versus the value of the property is known as the Loan To Value (LTV) amount. For example, if you wish to purchase a house at £200,000 and you have a deposit of £50,000 you would need to take out a £150,000 mortgage, or 75% LTV (150,000/200,000 = 75%).
The amount you can borrow for a mortgage is determined by your income, or joint income for a couple owning a house together. Different banks and building societies calculate the maximum mortgage allowances in different ways, depending on the policies of the institution. An example calculation would be you could take out a mortgage of no more than 4 times your annual salary, or 4 times your annual salary plus 2 times your partners salary.
In recent years, banks have offered high LTV amounts of 90%, 95%, 100% and even in some cases more – offering loans of more than the value of the property in exchange for higher interest rates on the loan. Higher mortgages allowances (5 times your salary or more) were also offered to homeowners to encourage the sale of more mortgages.
Eventually, this led to a significant number of people borrowing more than they could afford to pay back and therefore defaulting on their mortgage. In the cases where the banks had loaned more than the property value, this left the bank with properties worth less than their outstanding loans and led to significant losses for the banks.
In recent months and years, there has been a large tightening on both mortgage allowances and LTV, leading to banks requiring large deposits and offering less mortgages. This caused a slowdown in the housing market and prices fell, leaving more people in negative equity and the cycle continued. During 2009 measures were introduced to encourage the banks to lend more and this is slowly resulting in more credit availability, more mortgage approvals, and a slow increase in property prices.
What Types of Mortgages Are Available?
A fixed mortgage is exactly how it sounds, a fixed interest rate. Borrowers agree a deal with the lender to pay a fixed percentage of interest over the period of the mortgage. The length of time the percentage is fixed for varies on the deal, but typically is in the region of 2 to 5 years. It can however last the whole term of the mortgage on some deals. After the fixed period ends, the mortgage interest is then charged at the lenders standard variable rate (SVR).
A variable mortgage is one where you are charged interest at a variable rate throughout the term of the agreement. Each lender has a standard variable rate that they charge which can go up or down during the course of the term depending on market conditions and typically changes in the base interest rate set by the Bank of England (BoE). The BoE meets on the first Thursday of every month to set the base rate depending on the conditions of the economy. When the base rate is announced, lenders use this to decide on their individual rates in relation to that. The difference between the base rate and the lenders variable rates can be significant and doesn’t have to change just because the base rate changes. It is at the discretion of the lender to change their rates depending on how competitive they want to be with their peers. In some instances, there are clauses in such deals that say the variable rate will never be above a certain percentage higher than the base rate. For example, an agreement may be that the variable rate will be set by the lender, but that will never be more than 2% above the base rate.
A tracker mortgage is one which is again related to the base rate, but the proportion of difference is fixed and the rate will always change when the base rate does. An example agreement might be, a tracker mortgage that is 0.5% above base rate. In this instance if the base rate was 5%, you would pay 5.5%. Every time the base rate changes, your interest rate is automatically changed to base +0.5%. The different can be above or below base rate. If you have a large deposit to put down you may be able to get a deal that tracks below the base rate, e.g. -0.5% below base, so in the example above you would end up paying 4.5% interest.
In a discounted mortgage, the interest rate you pay is a set amount under the lenders Standard Variable Rate, again for a fixed period, after which you revert to the SVR. This may be a fixed discount for the fixed period, or it may be a “stepped” discount, where it changes over the course of the fixed period. For example, your deal may be 1% less than SVR for the first year, 0.5% below SVR for the next year, and 0.25% below SVR for the third year. After this you would revert to the SVR.
Repayment vs Interest Only
You may be asked which type of mortgage you want when searching for the best deals and may be wondering about the difference between repayment and interest only mortgages. Repayment mortgages are the most common, where your monthly payments cover the amount of interest charged in the month, plus a small amount of the overall loan. This means over the course of your mortgage, the amount you owe gradually comes down, so that you are completely paid off by the end of the term.
An interest only mortgage on the other hand, is one where your monthly repayments only cover the interest charged each month, and the overall amount of the loan remains the same until the end of the agreement. At the end of the agreement, the original amount that you borrowed must be repaid. The benefit of the interest only mortgage is that your monthly payments are lower than that of a repayment mortgage, however you have to ensure you have the money to repay your full loan amount at the end.
What Else Should I Know?
Another thing to watch out for is fees for arrangement, and other costs associated with taking out a mortgage. Most lenders will insist on some form of valuation of your property which usually you have to pay for, and there may be other surveys or inspections to be carried out. An arrangement fee is also charged on top of this for dealing with the paperwork and setting up your account. Usually you will find the deals with the lowest interest rates, will be the deals with the higher arrangement fees. This may mean that the lowest rate is not necessarily the best rate when you consider the cost of an arrangement fee over the course of the loan.
If you want to pay off your mortgage a bit early, making overpayments is a great way of helping you do this. It can save you significant sums of money in interest, as for every overpayment you make, there is less money to calculate interest on throughout the remaining lifetime of your loan. Be careful though, and check the small print of your deal, as some may have clauses preventing you from making any overpayments. Some may limit overpayments to a percentage of your monthly payments, or a fixed amount, say £500 per month. If you exceed these limits, you may be liable to paying an Early Repayment Charge (ERC) which is normally a percentage of the remaining loan, so can be a significant amount.
How Do I Find The Best Deals?
There are literally hundreds, if not thousands of different mortgage deals available, which are aimed people of differing circumstances. People who have small deposits will only have access to a limited range of deals, and normally will have to succumb to higher interest rates. The banks see people with larger deposits as a more attractive and safer proposition and therefore offer the best rates to people in this category. Some people prefer knowing exactly how much they are going to have to pay out each month and so opt for fixed deals, whereas others have the financial flexibility to cope with fluctuating rates and so opt for variable, or discounted rates. Navigating through this many options can be difficult, and there are a number of options you can take to decide on the best deal:
- Comparison sites – various mortgage comparison sites have sprung up in recent years such as moneysupermarket.com, confused.com, and so on. These sites take some basic information from you and filter out irrelevant offerings from multiple lenders leaving you only the results of interest to you. You can then see which deals are the cheapest over the lengths of any deals, taking into account arrangement fees etc. Many people change their mortgage provider every 2-5 years to ensure they are always getting the best deal. Be careful with these sites though, they make their money in commissions from loans taken out via their sites, and so in some cases they may put the lenders offering them the highest commission further up the list
- Bank/Building Society Advisor – Your bank or building society will almost certainly have a specialist advisor who you can talk to about mortgages who can give you some great advice. The only drawback with this option, is that often they are only interested in offering information on their banks products and so you don’t get a full picture of what their competitors offer
- Independent Financial Advisor – These work in the same way as your bank or building society advisors, only they are independent of the lenders and therefore can give you advice on multiple lenders products. They may charge you a fee, get a commission from the lender, or both.
- Mortgage Brokers – There are companies who are setup to do this work for you. Some of which charge a fee, and some, such as London and Country, who do it for free. The broker searches all the best deals from as many lenders as they can and advises on the best for your circumstances. They normally handle all the paperwork and applications, making it a very easy process when done correctly. Again, they may gain commission from the lender.
What If I Have Difficulties With Repayments?
If you get yourself into difficulty repaying your monthly loan, talk to your bank as soon as possible. They may be able to switch you to an interest only mortgage for a while, or give you a payment holiday (where you still accrue interest but don’t make any repayments for a number of months). They may also be able to extend the term of your loan to bring the payments down, or they may offer you back any overpayments you’ve made already. All of these and other options are available to you if you’re having short term financial issues, for example if you have unexpected costs, become unemployed for a few months, or maybe your partner is on maternity leave. The banks would much rather try and work out a deal with you and keep you repaying the loan than take away your house and potentially have a property worth less than the loan. Golden Rule…always talk to your bank as soon as possible if you think you are going to have difficulty.
It is also worth considering some form of payment protection insurance to protect yourself against these things. For example you can buy insurances to protect you in the event you are off sick from work long term, lose your job, or have a critical illness.
Some lenders will insist on you having some sort of insurance of this type, as almost all will insist on you holding valid home insurance (buildings only minimum).
UK Mortgage Guide Summary
To summarise, a mortgage is one of the biggest, if not the biggest, debts you will have in your lifetime, therefore it is important to take your time over the decision. If in doubt, always consult a qualified financial adviser, making sure they are registered with the Financial Services Authority (FSA). Make sure you are realistic about the amount you borrow, and more importantly, the amount you can afford to pay back on a monthly basis. Most deals have an introductory offer for the first 2-5 years which then leaves you on the SVR later, if the SVR is significantly higher at that point will you be able to afford it? Always remember to check for hidden costs or fees and ensure you know who’s paying them! Finally, once your deal is agreed, the money transferred and all is done, enjoy your new home!! I hope this UK Mortgage Guide has been useful, for more key words and terminology, see the below terminology link to Wikipedia: