Beginners' guide to mortgages

Learn more about the basics of mortgages, including the different products available, the fees involved, repayment and insurance options.How to cut the cost of your mortgage

A mortgage is essentially a large loan that's used to buy a property.

It's secured against the property you've bought to protect the lender, meaning that if you don't keep up your monthly repayments, the property could be repossessed.

If you already have a mortgage, you can switch to another product or lender without moving house by remortgaging.

Your monthly mortgage payments

When you take out a mortgage, there are two broad options for how you make your monthly payments: repayment (also known as 'capital and interest') and interest only.

Repayment mortgage

A repayment mortgage is calculated so that you repay the entire debt including interest over a specified period or term - commonly 20 or 25 years, although mortgages stretching over 30 or even 40 years may be available, depending on your circumstances.

When you first take out the loan you'll be paying a large amount of interest on the debt so your monthly repayments will mostly go towards covering this.

Did you know...?

  • The more attractive mortgage deals are likely to be available to those with the smallest loan-to-value ratio

As you continue with your repayments, they'll start to reduce the mortgage debt more and more and should eventually pay it off.

Interest-only mortgage

With this type of mortgage you only pay off the interest during the term, so your monthly repayments won't eat into any of the actual debt.

This means that at the end of your mortgage term you'll still owe the original loan amount, and to purchase the property you'll then need to find the money to clear this.

Before offering an interest-only mortgage, lenders will require proof that a reliable plan is in place to build up the funds that will eventually be required to purchase the property.

Such mortgages are becoming increasingly rare for residential purchases because they're considered a high risk to lenders - and to borrowers, who may be left without a home at the end of the term.

However, they're still commonplace for buy-to-let mortgages, with the repayment strategy of selling the property in the future to repay the loan.

Lending considerations

When deciding whether to grant an applicant a mortgage, lenders will take into consideration a number of different factors to see how high a risk they pose.

These include the borrower's loan-to-value ratio, credit history, age, salary and if they have a history of borrowing money and repaying loans.How to improve a credit score

In April 2014 the Financial Conduct Authority strengthened rules governing affordability when arranging a mortgage, meaning that lenders introduced more stringent checks and tests.

Borrowers need to demonstrate both that they can afford the mortgage at the time of taking it out, and that they'll be able to afford repayments in the future.

Lenders will therefore ask for detailed information regarding income and outgoings and will consider how potential rises in interest rates could affect a borrower's ability to meet mortgage commitments.

Deposits and loan to value

The loan-to-value (LTV) ratio refers to how much of the property is being financed by the lender and how much is being funded by the borrower, essentially showing the level of both you and your lender's equity in the property.

Top tip

If your loan-to-value ratio is high you'll pose a higher risk to the lender because it'll need to put more money on the line and the likelihood of you not being able to pay it back is greater, whereas those with a smaller loan-to-value ratio are seen as a safer investment.

Consequently, the more attractive mortgage deals are likely to be available to those with the smallest loan-to-value ratio.

Because of this, it's a good idea to save for a mortgage deposit when you're looking to buy a property, or to think about overpaying your mortgage to increase your equity level if you already have a mortgage.

Low-deposit mortgages are now far harder to come across than they were in the past, but there are a few 95% options around, often aimed at first-time buyers.

Mortgages for 100% of the property price are now extremely scarce, though.

Obtaining mortgage advice

Before speaking to a mortgage adviser, broker or lender, you need to decide what sort of advice you're seeking - be wary of confusing off-the-shelf information with advice as the two things are very different.

Since April 2014, lenders have not been allowed to offer residential mortgages on an 'information only' basis. They now must also advise you of the most suitable product from their range based on the information you provide to them.

Home phoneThey may also give you information in the shape of product terms and conditions, leaflets and mortgage comparision tables.

If you're choosing a mortgage with the help of a broker or adviser, you'll be talked through the various options available to you.

The adviser will look at what you can afford, assessing whether a particular product meets your needs and is suited to your circumstances, before recommending a product.

If you decide to visit or call a broker remember that:

  • Not all brokers offer products from the whole market - they may only offer products from a limited number of lenders
  • Some lenders offer exclusive products via their branch network, call centre or website - these won’t be available through a broker

Gocompare.com has partnered with London & Country for fee-free, award-winning mortgage advice. You can speak to them by requesting a call back through our main mortgage landing page, or by calling 0800 073 1959.[1]

Choosing a term length

Picking the term period is an important part of applying for a mortgage.

The longer the term, the smaller your repayments will be each month, but you'll have to pay more interest in the long run.

By opting for a shorter term, you'll have higher monthly repayments but will end up paying less in total.

Did you know...?

  • Some lenders will refuse to lend to anyone who will still be making repayments into their retirement

It's also worth considering how old you'll be when the term ends as some lenders will refuse to lend to anyone who will still be making repayments into their retirement.

Always make sure that you're able to make your repayments comfortably and don't opt for an amount which will stretch you financially - if you fall behind on your payments, you run the risk of your property being repossessed.

Types of mortgage

There are a variety of different mortgages to suit different individuals and circumstances. The most common include:

Standard variable rate (SVR) mortgages

This mortgage option means that your payments will fluctuate in accordance with the lender's standard variable rate, which the lender can change at any time.

This rate will often, but not always, be driven by the Bank of England's base rate.

Your monthly payments could go up as well as down, and remember that rates can vary widely between lenders.

This typically tends to be one of the more expensive mortgage options, but there shouldn't be any redemption penalties associated with it.

This means that you should be free to switch lenders or products, or to pay your debt off in full whenever you like, without being charged.Thatched cottage

Fixed interest rate mortgage

With this type of mortgage you'll be charged a fixed rate of interest for a set term.

Your payments will remain the same even if interest rates fluctuate. If interest rates go up, your payments won't increase, but if they decrease you won't benefit from it either.

A big advantage of this type of mortgage is that it can make it easier to budget as you'll know exactly how much you'll be paying each month.

Remember, though, that once the fixed rate ends you'll be moved onto your lender's standard variable rate, and the interest rate could then change at any time.

Note that fixed interest rate products almost always include early repayment charges for repaying or remortgaging before the end of the fixed period.

Tracker rate mortgages

A tracker rate mortgage is variable and is set at a percentage above or below the Bank of England base rate or the lender's SVR, which it then 'tracks' whenever it goes up or down.

Remember that you won't be certain about the level of your monthly payments and you must make sure that you're able to repay a higher amount if you're required to, especially since this type of product tends to carry early repayment charges.

Capped interest rate mortgage

Capped interest rate mortgages are tracker mortgages, but they'll be capped at a certain level (known as the ceiling) above which they can't rise.

Such a cap will only apply for a set period, after which you're likely to be switched to the lender's SVR.

Did you know...?

  • Once your initial fixed, tracker or discount deal has ended, you'll probably be moved onto your lender's standard variable rate

Remember that the cap could be set at quite a high point, so make sure that you'd still be able to make your payments if they were set at the highest possible amount.

Some capped rate mortgages also have a 'collar', which means their interest rate will never drop below a set figure either, even if the rate the mortgage tracks drops lower than this.

This type of product will generally have an early repayment charge, making it more difficult to switch lenders or pay off your debt early.

Discounted interest rate mortgagesBuying a home infographic

Payments on a discounted rate mortgage will be variable but will be below the lender's standard variable rate for a set period of time, usually about two or three years.

You're likely to be moved to the lender's SVR once that period has ended.

Note that if interest rates drop, so could your rate, but there's no guarantee that the standard variable rate will move according to the Bank of England base rate - it's up to the lender.

As with most mortgages with an introductory deal period, this option almost always includes an early redemption charge.

Flexible mortgages

A flexible mortgage enables you to change or vary your monthly payments according to your needs.

You can even pay the loan off early if financially possible, lowering the amount of interest that you have to pay on your mortgage overall.

Some flexible features are becoming more common on other types of mortgages too, such as overpayments, underpayments, payment holidays and extra borrowing.

Many flexible mortgages are free of early redemption penalties, so you're able to switch products or providers whenever you need to.

Remember to factor in associated fees and interest rates - these may outweigh the benefits you gain from flexibility.

MortgagesOffset mortgages

Offset mortgages link your mortgage to your main current account and/or savings account.

The higher the balance of the account your loan is linked to, the less interest you pay on your mortgage. However, if your balance decreases, you'll pay more to compensate.

Note that because you don't earn any interest on your current or savings account, there's no tax to pay on your savings interest.

Interest rates and arrangement fees can be relatively high on this type of mortgage - whether it's an option that benefits you will depend on the way you manage your month-to-month finances.

Cashback mortgages

A cashback deal will pay you a lump sum when your mortgage or remortgage completes and may be offered in conjunction with another benefit, such as an interest rate discount.

The rates are typically higher with a cashback mortgage to counter the lump sum paid out, though, and you should also take into account the mortgage fees when deciding whether the cashback deal is good value for you or not.

Did you know...?

  • Mortgage indemnity insurance is a product designed to benefit and protect the lender, but it's often paid for by the borrower

Mortgage fees

Although you may think that finding a mortgage with the lowest interest rate is the priority, the various fees added to the product could make the overall deal more expensive than other, higher-interest options.

Individual mortgage products differ greatly in the fees they charge, but you might find some, or all, of the following attached to your chosen product.

Booking fee

Some mortgages levy a booking fee (or application/reservation fee, as they're also known) which is charged up front and is essentially for booking the loan while the mortgage application goes through.

As booking fees are non-refundable, you usually won't receive your money back if your application's unsuccessful or you decide not to take out the mortgage.

Arrangement fee

An arrangement fee is the charge levied by the lender for setting up the loan.

You usually have the option of paying the arrangement fee up front or adding it to your loan. You'll be charged interest on the fee if you choose the latter option, which means you'll end up paying more in the long run.

The arrangement fee will either be a set amount or a percentage of your borrowing, which could be a significant sum if you're taking out a large mortgage.

Valuation fee

Valuation fees cover the cost to the lender of conducting a basic survey of the property that you're looking to buy to verify that the house is adequate security for the loan.

You may be able to find a lender that includes a free survey with their product, although you should consider the overall costs of such a deal.

Lender's legal fees

You'll of course have your own conveyancing costs to cover, but some lenders also ask you to pay for their solicitor costs, which can be a few hundred pounds.

You may be able to find fee-free or assisted fee deals that cover the cost of the lender's legal work.

Homebuyer Reports and structural surveys

It could be worth investing in a Homebuyer Report or full structural survey, especially if you're buying an older property which has been renovated, is of unusual construction, or is a listed building.Log cabin

This is likely to cost more than a standard valuation fee, but will provide you with invaluable information on what is a very important purchase.

Legal charges

Legal fees pay for a solicitor to complete the legal paperwork involved in taking out a mortgage, known as conveyancing. These fees include:

Conveyancing

Your solicitor or conveyancer will charge for their legal work to prepare the transaction.

Search fees

A search fee will cover the charge for searches from the local authority for any planning, local or drainage issues that may have a detrimental effect on the property you want to buy.

The searches will usually be co-ordinated by your solicitor.

Note that legal fees will be more expensive for purchasing a house than remortgaging a property.

Stamp duty

Stamp duty is the tax that must be paid in one lump sum if you buy a property or piece of land costing over a certain price threshold.

The amount you have to pay will depend on a number of factors, including the price of your home.

Remember!

  • Whatever insurance you need, you don't have to purchase it from your mortgage provider and you could benefit from shopping around

Early repayment charges (ERC)

Some mortgage options such as fixed rate or cashback products may require you to pay an early repayment or early redemption charge if you want to pay off the debt early, or switch to another product or provider.

Overhang

An early repayment charge overhang is when the lender extends the early repayment charge beyond the period during which you had a fixed, capped or discounted rate on your mortgage deal.

This clause has fallen out of favour, but you should check the terms of your chosen mortgage deal to make sure you're clear on how long early repayment charges will apply for.

Insurance options

A mortgage may well be the most important financial commitment you ever make, meaning that you should think carefully about your insurance options.Income protection

Buildings insurance will be insisted upon by all mortgage providers, while some will also demand mortgage indemnity insurance if you have a high loan-to-value.

Your lender might also be keen to sell you mortgage life insurance, although this shouldn't be a requirement of taking out the mortgage itself.

You may also want to think about your income protection insurance options; some such policies are specifically designed for mortgages and called mortgage payment protection insurance.

Whatever insurance you need, remember that you don't have to purchase it from your mortgage provider and you could benefit from shopping around - read more about all such areas in our article on mortgages and insurance.

By Abbie Laughton-Coles