The Basics of Mortgages
DATE: 5 August, 2021 // Read more from the Blog »
What is a mortgage?
A mortgage is a type of loan that is secured against a property, in short this means if you don’t pay they take it away. During the process of the mortgage being arranged a solicitor or conveyancer will need to complete the relevant legal paperwork including setting up a legal charge against the property. The legal charge is registered with HM (Her Majesty) Land Registry, this is to stop the person from selling the property without repaying the loan. A bit like the DVLA with car, they know who owns what. It is also the charge the lender can use to force the owner to sell the property or take legal ownership by force if they don’t make the payments. When the lender takes legal ownership, this is called repossession.
What will I need for a mortgage?
During the process of house buying the advisor will need to get some documentation from you and fill in a factfind, this is a questionnaire so that they know the details about you necessary to provide advice and complete the application form once ready. They will assess the affordability and give you an indication of how much you could borrow so you can go house shopping
What can a mortgage be used for?
Mortgages can be used to buy a property for a variety of reasons, residential use for the applicant(s), second homes such as for a family member or a holiday home, buy to let properties with the purpose of renting out for a profit. They can be used to buy holiday rental properties, to buy land and build a property on, to convert a barn or other building, they can be used for commercial premises, and the most bizarre option I’ve come across is to buy a forest. That’s right, a forest, a wooded area. It generally needs to be a static structure or property, something not temporary that could be moved. For example, house boats, caravans (including static) or holiday lodges with short leases.
How long can a mortgage be?
The term of a mortgage can be much longer than a typical loan, some lenders will let you take a mortgage up to 40 years, although for many this isn’t a wise choice. By having the security of the legal charge, the lenders are also able to lend considerably more than they would otherwise. But as it’s based on affordability you can be limited on how much you can borrow based on your income. Lenders will typically lend up to 4.5 times your income, minus debts and other outgoings. This figure can be higher though, some will allow up to 5x, some even more than that, but it is based on circumstances, there isn’t a one size fits all. It’s also based on the term of the mortgage, for example borrowing £100,000 over 10 years vs £100,000 over 35 years, obviously the longer term will attain a lower monthly payment and thus lenders typically won’t let you borrow as much over a shorter period, even though you may think you can afford it. Ultimately, both the lender and the applicant can set a minimum and or maximum, if either aren’t happy with an application in progress they can walk away.
Interest and repaying the mortgage
Like other loans and credit agreements mortgages include an element of interest, a percentage of the balance that is charged. This is where the lender makes their profit. Mortgages generally have monthly payments, which repays the interest owed and on a repayment mortgage they include an element of the debt too. The majority of mortgages today are on a repayment basis so when the term comes to an end the debt is fully repaid. Whilst there are options this is usually the preferred option for most people as both the applicant and the lender know that the debt will be gone by the end of the agreed term assuming all the repayments are made on time.
What are the different mortgage products?
There are different types of mortgage products available fixed, tracker, variable, discounted, capped. Fixed rates are the most popular as it allows for a fixed rate of interest until a specific date or for a specified period of time e.g., 2 or 5 years. A tracker is generally a set amount above the bank of England base rate, if the base rate goes up so do your payments, if the base rate goes down so do your payments. There can be a cap and collar though, this is a minimum and maximum so the interest rate can’t go beyond these limits. Think of these like a cap on your head and the collar of a shirt, top and bottom. A variable rate is generally quite a simple and basic product with little to no features, the lender can change these regularly if they chose to (although they tend not to). Discounted deals are just a discounted variable rate, they usually follow the lenders standard variable rate minus a percentage e.g. 1%. A capped product (whilst few and far between) is a discounted variable rate with a cap and collar to limit interest rate fluctuations. Fixed rates are generally the preferred option but the others can have benefits that’s fixed rates usually don’t. For example, if the interest rates were to reduce a fixed rate would stay as it was, equally if they went up the mortgage would be protected until the deal came to an end. Variables and trackers can have lower early repayment charges or even none at all which can be ideal for when people plan to sell a mortgaged property.
How long does a mortgage product last?
The deals available for mortgages can differ in length as well as style, the most common are 2 & 5yrs long. That being said they can be shorter (although very few and far between) and longer. Typically, the longest fixed rate is 10 or 15 years but some trackers do last the life time of the mortgage. Whilst a life time tracker will generally only have early repayment charges apply to the early years, a longer fixed rate will typically have longer and more expensive early repayment charges to match. Generally, the longer the fixed rate the higher the interest charges and the higher early repayment charges are the longer they last. So, they’re great to protect yourself from interest rate changes, but if you have to redeem the mortgage you could end up bitten in a rather nasty way. Whilst a shorter deal like a 2-year fixed may have early repayment charges start at 3% a 5-year fixed may start at 5%, longer deals can have even higher penalties. So, on a £200,000 mortgage you could be looking at £6,000 vs £10,000. The longer deals can be higher again so you want to be mindful of the prospect and potential for change when you’re looking at the deals available.