How do mortgages work?

How do mortgages work?

This page was last updated on 1 July 2021

How do mortgages work?

Mortgages are complicated products. Keep reading to have mortgages explained in our handy guide on how they work.  We discuss mortgage rates and how the mortgage application process will work, to help make buying a house easier. 

We also discuss the different types of mortgage available, such as buy to let mortgages, help to buy, equity release mortgages, and the most common type: repayment mortgages.

Topics that you will find covered on this page

You can listen to an audio recording of this page below.

 

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How do payments on a mortgage work?

Buying a home or land is expensive. A mortgage is a financial product that helps people purchase their own home or land.This is especially true for a first time buyer, as it might be the only route onto the property ladder.

Essentially, it helps you afford to buy a home. The most common type are repayment mortgages. Firstly, you pay a deposit. Then, you make monthly repayments, which include interest, until your debt is no more. 

They are long term loans, so you pay off the mortgage value over a long period of time. The term of a mortgage is something you can negotiate based on your needs, finances, and property value. 

Until your loan is repaid it is secured against your property. So, if you fail to meet monthly payments, your home and possessions can be at risk. 

Here is a video on how mortgages work.

How long are mortgages?

Mortgage lengths can vary based on the plan you choose, amongst other variables. Plans vary from 6 years to 40 years, though typically people have 25 year contracts. 

How does a 30 year mortgage work?

This, and anything longer,  is classed as a long term mortgage. You make monthly payments to repay the borrowed amount, plus interest, for 30 years. 

With a policy of this duration, the value of monthly payments might be lower, but over time the higher interest rates charged can add up. This can make a 30 year mortgage more expensive than a shorter one. 

What happens when I decide to sell?

If you want to move house there are different options on offer. 

Option number one is to stick with the same mortgage. This is known as ‘porting’. The other option is to remortgage. This allows you to change lenders. Use a guide or advice from mortgage brokers to find the right choice for you. 

get a mortgage

How does porting mortgages work?

In simple terms, your mortgage lender will move your mortgage deal to your new purchase. So, the borrower stays with the same lenders. 

However, you still need to undergo an application process. When you first get a mortgage you must prove to the provider you can afford repayments. When you port your mortgage onto a new property, you have to convince them and apply for a mortgage again. 

They then choose to accept or decline your proposal to transfer your mortgage. Often, there will be fees involved in making a transfer. Ask about these beforehand, to avoid unexpected charges. 

What happens in a  remortgage?

Remortgages allow you to change lenders, and sometimes even get a better deal if one is on offer. But, it can be complicated  if you’re tied in to an old mortgage.

If you have not reached the end of the term than remortgaging can involve ‘early repayment charges’. After paying these fees, then you can take out a policy for the amount needed to buy a home..

"Mortgage lengths can vary based on the plan you choose, amongst other variables. Plans vary from 6 years to 40 years, though typically people have 25 year contracts. "

What if I cannot sell my home in time to buy a new one?

Bridging loans can help you find the finances to apply for a mortgage and proceed with buying a new home while waiting for your old home to sell. This gives you more time to find the right buyer, without stopping you from buying a home. 

Is a bridging loan a good idea?

When purchasing a house, competition can mean you have a short time to complete your purchase. Waiting for it to sell for the right amount might mean losing out on the home you want to buy. 

However, bridging loans often have a high amount of interest charged. With such high fees, you should consider whether it is really essential. You should also think about whether the amount is something you can actually afford. 

If you are thinking about taking out a bridging loan, seek independent financial advice before doing so. When you take out this product you are essentially the owner of two properties until your previous home sells. If you have other options available, it is often better to take these. 

What is the mortgage interest rate?

Interest rates vary depending on the mortgage deal you go for. An independent mortgage broker can help you find a deal with good interest rates on mortgage payments.  

Is interest a fixed rate?

There are two types of rates available when it comes to a repayment mortgage.

With fixed-rate mortgages the rate never changes. So, each month your repayments are the same. Many homeowners prefer to have this peace of mind. 

A variable rate mortgage has an interest rate that fluctuates over time. This means your monthly payments change, sometimes for better but sometimes for worse. Fluctuations often parallel the base rate of the Bank of England.

What are the risks involved with a mortgage loan?

When you take out a home loan, you sign a contract as an agreement to repay the amount plus interest. Your home is used by the lender as collateral against your debt. So, if you fail to meet your end of the deal there can be severe consequences.

The biggest risk is that the lender or bank might repossess your property. This is because if you do not meet your repayments your are essentially surrendering the ownership of your home. 

What are the different types of mortgages?

There are multiple different mortgages out there. The main types with smaller deposits, and include:

  • Help to Buy mortgages, which require a smaller deposit
  • First time buyer mortgages
  • Right to Buy mortgages for those looking to purchase their social housing 
  • Guarantor mortgages 

There are also different mortgages based on financial circumstances. For example, you could get a mortgage for bad credit, a mortgage without a deposit, a self-employed mortgage if your income is hard to prove, an interest only mortgage, or a commercial mortgage for your business. 

If you are buying a property for a specific purpose, the mortgages to consider are buy to let mortgages, second mortgages, lifetime mortgages, and commercial mortgages. 

What happens if I can’t afford repayments?

If you cannot afford your monthly bill, the lender might take your home in a foreclosure. 

The best thing to do if you start struggling to make repayments is to contact your provider. They might have some solutions, such as lengthening the mortgage term in order to reduce the monthly cost, or temporarily put you on an interest only mortgages.

You should also see about eligibility for government support. For example if you claim Universal Credit, Income Support, or Employment and Support Allowance (ESA) you could get Support for Mortgage Interest (SMI) . 

You might also be eligible for benefits to increase your income, which in turn can make repayments more achievable. Another thing to consider is re-evaluating your budgeting and monthly spending. 

Ultimately, it is important to compare mortgages before taking one out, to avoid this situation.

Who can get a mortgage?

To get a mortgage you must be purchasing a property or area of land. Then, you can search for lenders- normally a bank or building society. Be sure they are regulated by the financial conduct society. 

The biggest requirement when it comes to eligibility for a mortgage is your credit score, so you will need to have a credit check.

Lenders will also likely look at your debt-to-income ratio (DTI), the size of your downpayment, and your income. 

What is a good credit score?

The minimum credit scores providers generally require is 620 or 640, for fixed-rate and variable-rate mortgages respectively. 

I have too weak a credit score, what can I do?

If you have a low credit score you could try certain government backed types of mortgages. 

As a rough guide, the rating for a government backed type of mortgage is 580, but in extreme cases scores as low as 500 have been offered. 

What is my debt-to-income ratio (DTI)?

Your Debt To Income is the total owed divided by gross monthly income/earnings. This gives you your DTI, as a percentage. 

The lower your DTI the more chance you have of being approved for the mortgage. Normally a lender will ask for a  DTI of 45% as a minimum. 

However, if you have a higher DTI but a better than average credit rating, you could be offered a mortgage, particularly if you have ‘reserves’. 

These highly liquid assets are favourable because they offer security- you could use these to pay your mortgage if you hit financial difficulty. 

Typically, if your DTI is higher at, say, 50%, you will need two months worth of these reserves. 

interest only mortgages

How much will my down payment be when applying for a mortgage?

Your deposit is a percentage of the total property value. This percentage varies between banks, and also between individual customers. This is because your personal situation is also taken into consideration.

For example, if you purchase a property for £300,000 with a 10% deposit your downpayment will be £30,000. The lender then pays the remaining 90%, which is the Loan-To-Value (LTV).

LTV is the percentage of your property’s value that you have to borrow from the lender. 

Providing you qualify, you could get a rate from your lender as low as 3% for a conventional mortgage. If you opt for a government-backed plan, generally the downpayment requirement is lower. Sometimes, no down payment is required. 

What do I need to take out a mortgage?

To take out a mortgage you must give sufficient proof of your monthly income. This is because the lender wants to be sure you have a consistent and sufficient source of money. Normally, you will need to provide official copies of documents such as:

  • Income Tax Returns
  • Payslips

What are the benefits of taking out a mortgage?

There are multiple benefits to taking out a mortgage. These include, as a rough guide:

  • Getting onto the housing ladder if you are a first time buyer
  • Improving your credit score
  • Giving you access to cash using the equity in your home later down the line
  • Providing you with tax benefits 
  • Allowing you to become a homeowner 
buy to let mortgages

What are the disadvantages of mortgages?

Despite the various pros of a mortgage, there are some drawbacks to think about. Since it is a loan, and a very large one, there are obviously risks involved. You need to be sure you are aware of these and comfortable with them before taking out your mortgage. 

The two main risks you need to be aware of include:

  • Losing your home in foreclosure if you can’t make repayments 
  • Devaluation of your property over time 

How does a mortgage work for first time buyers?

Taking out a mortgage can understandably be daunting. Here, we simplify how to get a mortgage.

Firstly, work out your credit score. The lower your credit rating the better interest rate you might get. 

Then, you should work out what costs you can afford to pay. If you are buying a property with a partner or loved one, have a chat with them to get their opinion and advice. An affordability calculator can help with this. 

When thinking about what you can afford, make sure you consider costs beyond simply the mortgage amount and interest. We discuss these later. 

Do some research to compare mortgages, and look at the different mortgage lengths on offer. See if you qualify for a UK government scheme, such as buy to let,  too.  

Are there any other fees or costs associated with mortgages?

In addition to the total loan value and interest, there are some other expenses you need to factor in. Homeowners insurance, mortgage insurance, and property taxes are some examples.

There are also application fees and mortgage broker fees, to cover the cost of advice. Advice, though an annoying additional cost at the time, can save you a significant amount of money down the line.

You should also think about the size of your monthly household bills. If you previously lived in rented accommodation, utilities and maintenance may have been included. When you become a homeowner these costs fall on you. 

Many people also want to renovate and redecorate when they move into a new house. So, budgeting for these is important too.

If this is not your first mortgage, you might need to pay early repayment charges or exit fees to get out of your old plan. You will also have valuation fees if selling your old property. 

Learn More About Mortgages In The UK

How do mortgages work in the UK?

Buying a home or land is expensive. A mortgage is a financial product that helps people purchase their own home or land.This is especially true for a first time buyer, as it might be the only route onto the property ladder.

The minimum credit score for a mortgage

ou can still be approved for a mortgage to buy a property if you have a poor credit score. However, someone with a poor credit score will probably have a higher interest rate than someone whose credit score is good. Buyers with a low credit score may also need to pay a bigger deposit.

fixed term Contract Mortgages

A fixed term contract is a way of describing certain types of employment. If your current employment contract is due to end after a certain period of time, or after a specific piece of work is complete, you are likely on a fixed term contract. 

how long does a mortgage application take?

After sending off the final application waiting for the decision can be frustrating. Many prospective homeowners ask ‘how long does it take?’ but the truth is the mortgage approval process is always different for each customer.

how long does conveyancing take?

The entire conveyancing process will normally take anywhere between 8-12 weeks, however you should be prepared for this to take much longer depending on your circumstances and wider factors. This articles explores what the timescale involves.

Mortgages if You are bankrupt

There is no hard and fast rule when it comes to what lenders will accept your mortgage application if you want to get a mortgage after bankruptcy. They will lend to discharged bankrupts and consider each case individually. 

what stops you getting a mortgage?

Everyone wants to get the best deal when it comes to buying a home and getting a mortgage when they buy a home. However, being too ambitious can lead to your application being rejected. 

how much do mortgage advisors charge?

Fees for mortgage brokers can be off-putting. A mortgage is an expensive financial product, and often buyers want to save as much money as possible. This might limit their options when it comes to using a mortgage broker.  However, not everyone advisor charges a fee.

IVA Mortgage

When you have an IVA, mortgage acceptance is still possible. However, involuntary agreement mortgage lenders can be hard to find. Typically, a high street company will be more less keen to give you a mortgage. 

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