First time buyer guide
What Is a Mortgage?
To put it simply, a mortgage is a sum of money you borrow from a bank or mortgage lender to help you finance buying a property. Its main characteristic is that it’s bound to the house you buy.
How Does a Mortgage Work?
Mortgages mostly work in the same way. You usually borrow a percentage of the value of the house and repay the loan plus interest. If you fail to repay you could lose your property as it may be sold to pay off your loan. This unhappy scenario is known as repossession.
To buy a home, you need to put down a deposit (a % of the house’s value) while the bank agrees to lend you the rest of the money. This is generally done over a 25 year period but it can vary, with many lenders now offering mortgages for a 40 year period depending on your age. The special favour comes with a price: interest charges.
What is LTV?
LTV, or loan-to-value, is the size of your mortgage in relation to the value of the property you’re buying. It’s expressed as a percentage.
So for example, if you have a mortgage of £240K and you’re buying a home that costs £300K, your LTV would be 80% (£240K / £300K = 0.8 x 100 = 80%).
If you have a high LTV the bank will see you as a riskier client. Therefore, they will probably offer you less competitive mortgage rates. To get the best rates you should aim for the lowest LTV possible.
Repayment & Interest-Only Mortgages
When you borrow money from a lender to buy a house you’ll either take out a repayment mortgage, an interest-only mortgage or a combination of both. Here we’ve outlined the main characteristics of the two:
- It’s a type of mortgage that allows you to repay the money borrowed (capital) together with the interest added by the bank or building society for lending you the cash to buy a property.
- Your regular monthly repayments will cover some of the capital and some of the interest.
- By the end of the mortgage term, if you’ve managed to keep up on the payments, you’ll owe nothing and the property will be yours.
- In the beginning, you’ll be paying more interest than capital. But over time – as the capital balance goes down and you get closer to the end of the mortgage – your payments will be covering more capital than interest.
- Interest-only deals are usually not suitable for first-time buyers. This is because they have stricter lending criteria. You’ll typically only be able to borrow up to 50% of the value of the property. Plus some lenders will only lend to people with incomes above £100k.
- This type of mortgage will have you paying only the interest every month. Then, you’ll have to repay the capital borrowed at the end of the mortgage term.
- What makes this type of loan attractive is that the monthly payments will be much lower than the ones for a repayment mortgage.
- But remember you’ll have to pay off the initial amount of the loan. If you can’t pay back the capital in full your mortgage lender could end up repossessing your property.
- You’ll need to save the money to pay off the loan by other means, such as investments or inheritance.
Types of Mortgages
There are many different types of mortgages to pick from. Here we’ve highlighted the ones you’re more likely to encounter:
a) Fixed Rate Mortgages
With fixed-rate mortgages, the interest rate you pay will be fixed for the length of the deal regardless of what happens to interest rates. The most common deal periods are 2 and 5 years. The rates you pay can sometimes be higher than on variable mortgages, and you won’t be able to benefit from a fall in interest rates.
b) Variable Rate Mortgages
With variable-rate mortgages, the interest rate can change at any point. The main types are:
Standard Variable Rate (SVR) Mortgages
Every lender has their own standard variable rate (SVR) which they can change as they like. They typically do this when the Bank of England’s base rate goes up or down.
SVR mortgages tend to be expensive as average rates are usually higher than those of fixed-rate mortgages.
With a discount mortgage, you will be charged the lender’s standard variable rate (SVR) minus a fixed percentage. For example, if your lender’s standard variable rate is 5% and they offer a 2% discount, you’d pay 3%.
The discount usually applies for a fixed length of time which is generally two to five years.
These mortgages can be some of the cheapest around but bear in mind that the rate can go up and down when the SVR does.
Tracker mortgages move in line with another interest rate – which is usually the Bank of England base rate. So the mortgage rate you pay will be a percentage above or below the base rate.
If the base rate goes up, so will your mortgage rate. And it will come down when the base rate decreases.
Offset mortgages work by linking your savings to your mortgage, so you only pay interest on the difference between the two. Each month, the lender deducts the amount you have in savings from the amount left to pay on your mortgage.
For example, if you have a £250K mortgage and £10K in savings, your mortgage interest would be calculated on £240K for that month.
With capped mortgages, the rate you pay usually moves in line with the lender’s SVR. But there is a cap on how high your rate can rise, which gives you some protection.
Other Mortgage Resources for First Time Buyers
There are a number of Government schemes to help first-time buyers onto the ladder. Some of these are designed to help you save for a deposit and others to support you with your mortgage.
Shared Ownership Mortgages offer the possibility of buying a share of a property – usually between 10% and 75% – and pay rent on the rest.
A Help to Buy Equity Loan is a loan from the government which covers part of the money needed to buy the house. This means you’ll need to borrow less cash from a traditional bank for the mortgage, giving you a wider choice of mortgage deals to pick.
With so much choice when it comes to picking a mortgage, it might be useful to consult a mortgage adviser. It’s also important for you to understand your affordability – that is, how much you can borrow – and check your credit score before you take the leap.