Where were you when you realised nowhere in society teaches us what a mortgage is?
I was taking a walk listening to a podcast when it suddenly hit me. No where through school, college or university did we have the explanation of what a mortgage is, how it works, the different types or how to get one. So, we at Fempire Finance are fulfilling our civic duty by writing a short guide to break it down.
So first things first, what is a mortgage? in the simplest terms, a mortgage is loan from a bank or building society used to help buy property. When you secure that property, your mortgage lender will secure the loan against the home. Meaning if monthly payments aren’t met, then the house could be in danger of being taken away. The good news is that when you finish paying the mortgage off, you will own the home outright.
How does a mortgage work?
There are normally two parts to buying a house. The first is generating and placing a ‘deposit’ - this is a lump sum, usually 5% or 10% of the total property price that will go towards the purchase, For example, if a property is £500,000 and a deposit of 10% is being asked for as a prepayment, you’ll have to pay £50,000 towards the property’s purchase price. The remaining cost of your home (£450,000) will be paid using a mortgage.
The £450,000 you borrow is what is known as capital and will needed to be paid back on a monthly basis as well as and have interest charged on it.
How long will I be paying a mortgage for?
Unlike normal loans such as a car loan, the average mortgage can last anywhere up to 40 years, so think of it as a form of very long term loan. – during which you’ll make monthly repayments.
So, now we know what it is, are there different types of mortgages?
The short answer to that is yes! There are a number of different types of mortgages suitable for different people and what you want to get out of it!
Here is a snappy round up of just 3 of them...
Fixed rate: When you hear of this, the interest you’re paying stays the same for a number of years at a time. For example, a ‘two-year fix’ or ‘five-year fix’ means you’ll be paying the same interest rate for that period. The good thing about this is that it is stable, as there will be no changes to your mortgage payments, allowing you peace of mind and the ability to budget accordingly. The one thing to know is that Fixed rate mortgages are slightly higher than variable rate mortgages, and if the interest rates dip, you won’t benefit from it. Whilst interest fluctuations are less of a threat, there may be charges if you want to leave the deal early as there are usually tie-in penalties, or redemption penalties associated with fixed rate mortgages.
Variable rate mortgages: These are mortgages where the interest you pay can change. If rates rise, your repayments will also rise. The most popular type of variable rate is the Tracker Mortgage. A tracker mortgage uses the interest rate set by the Bank of England. So when this changes, your mortgage will change too. On today's date, the Bank of England base rate is 0.1%. Banks and building societies usually put their interest rates way above the Bank of England base rate so they make a profit. So if your mortgage interest rate is at 2% above the Bank rate, which is at 0.1% now, the interest rate payable would be 2.1%.Let’s say, the economy is recovering from Coronavirus (we’re manifesting here) and the Bank of England increase their base rate back to 0.5%… payments would then be based on this plus the 2% your mortgage has as standard, so altogether your interest has risen by 0.4% to 2.5%, so you’re paying more - and thats the nature of variable/tracker mortgages. A bit more riskier than a fixed rate mortgage.
Capped rate mortgages: An upper limit to the interest rate will be set. This is a rate that means, your interest rate can’t rise above a certain level. Your lender can change the Standard Variable Rate up and down but not above the cap level.
An important term to know here is Standard Variable Rate. This is type of mortgage interest rate that you are most likely to have after finishing an introductory fixed, tracker or discounted deal.
Cool, what are First-time buyer mortgages and Buy-to-let mortgages?
We love to see more homeowners and so do many Governments around the world, which is why they have introduced first time buyer mortgages. Usually with a lower amount required for the deposit.
Buy-to-let mortgage are mainly interest-only. Buy to let purchases is when a house or flat is bought solely for the purpose of it being leant out to renters. So you will still owe the initial amount borrowed (capital) at the end of your mortgage term and only the interest on the loan is paid.
How do I find a mortgage?
The 21st century answer is applicable here, and that answer is 'Google it'. The internet will allow you to delve deep into the different mortgages offered. A top tip would be to use sights like Experian and Compare The Market to look at the pros and cons of all the different mortgages, and find the right one for you. Once you’ve found the bank or building society that is right for you and you choose to apply, they might sift for more information about your earnings and credit history to determine the right product for you.
Drafting in professional help is also a plus. Seeking a mortgage broker early on will make the tailored search easier for you. You can tap into a mortgage brokers market knowledge, insight, expertise and experience.
Just to note, when applying for mortgages they are often time bound, lasting for three to six months. If this period expires, you may have to ask for an extension. We should also say that asking for mortgages continually may damage your credit score.
Okay, but what is a mortgage in principle? A mortgage in principle is basically a thumbs up from the bank or building society that says they are willing to lend you money. It can be great to get one of these as you are about to view properties as it shows your commitment to buying a house.
And finally, whats a remortgage?
When you hear the term remortgage, think of it as taking out a new loan with your existing lender (bank or building society) or jumping ship and finding a new lender. Remortgages can happen for a number of reason, the first is to change the type of interest on a mortgage - remember when we spoke about fixed and variable rates earlier? Well remortgaging is a common way to switch from one to another. Other reasons may be to get a better interest rate, free up equity (that’s the difference between what you owe on your mortgage and the current value of your property) in order to divert money somewhere else, for example home improvements.
We also wrote a post explaining all the costs of home buying. Here’s hoping this demystifies some of the complexities of mortgage that are out there. Look out for more posts on the home buying journey.