Understanding Mortgages: The Basics

 Family settling into their new home

Applying for a mortgage is a big financial step, and the mortgage offer you are given can depend on a number of factors. There are a range of different types of mortgage lenders who may assess various aspects of your financial situation to determine how much money they are willing to lend you, and the terms under which you will pay it back.

How Are Mortgages Calculated?

When you apply for a mortgage, lenders can analyse different components of your finances:

  • Credit Report – Your credit report contains information about your credit history. If your credit history shows lenders that you have borrowed money (within your limit) and made repayments on time over a long period, this can positively affect your credit score.

    Your score is calculated based on the lender’s assessment of your credit report and information provided as part of your application. However, if your history shows poor financial behaviours (i.e. taking a loan and not making repayments on time), this could negatively impact the credit score you are given, and may make it more difficult to successfully apply for a mortgage.

  • Income – Lenders use your basic salary or wage to help gauge your financial situation, as well as reviewing any overtime, bonuses, or commission. Other sources of income that could be taken into account are child benefits, family tax credits, maintenance payments, or income from investment bonds.

  • Outgoings – Lenders will want to see details and evidence of your outgoings to assess the financial commitments you have. This helps them judge if you will be able to afford the mortgage. Contractual payments such as rent, electricity and gas bills, phone and internet bills, child support agency payments, school fees, loan agreements, and credit card repayments all count as possible expenditures.

  • Deposit – The size of your deposit can impact the interest rate you are offered. The loan-to-value (LTV) of a potential home can tell you how much of the property you would own compared to the amount secured against the mortgage.

    For example, if you had a £25,000 deposit on a house worth £250,000, your deposit would count for 10% of the property price (which is the part you would own), while the loan-to-value would be the remaining 90% (which is the part secured against the mortgage). Having a bigger deposit reduces the LTV, and may lower the interest rate on your mortgage repayments.

Typical Mortgage Lenders

Mortgages in the past were usually between the borrower and the lender, most commonly a bank or building society. However, buyers can now borrow from a range of different mortgage providers.

Traditional and High Street Banks & Building Societies

  • Going directly to a bank or building society can give you access to mortgage deals that may otherwise be unavailable if you go through a middleman or broker.

  • However, this can also limit your choices, as you’ll only see deals from that provider, and they may not necessarily be more desirable.

  • Some banks may provide discounts to existing customers for their loyalty.

Mortgage Brokers

  • Mortgage brokers act as middlemen between the borrower and the lender. As many brokers will evaluate a number of different deals from various lenders, they offer a wider range of deals than one specific lender.

  • Some lenders may provide deals exclusively through brokers that wouldn’t otherwise be available to borrowers.

  • Brokers can also provide a level of convenience – you may only need to give your details once and the broker can use these to find the best deals.

  • Mortgage brokers may charge extra fees for their service.

Alternative Banks & Mortgage Providers

Some borrowers are also looking to supermarket banks for their mortgages. As these alternative banks are relatively new – it can be worth researching and shopping around before making a decision.

Repaying the Mortgage

There are two parts to the mortgage that you have to pay off – the capital (the money you borrowed) and the interest (the cost of the money you borrow).

A common way to pay back a mortgage loan is through a repayment mortgage, which involves paying both the interest and the capital over the term of the agreement. The mortgage balance should decrease with every month of payment, and as long as repayments are made on time, the mortgage should be paid in full at the end of the agreed term.

Some buyers opt for an interest only mortgage - you only pay the interest on the amount borrowed each month. Your monthly payments may be lower than a repayment mortgage, but the capital (the money borrowed) will still need to be paid back. Lenders may ask for a larger deposit for interest only mortgages, and/or may require you to have a repayment plan in place to pay off the original amount at the end of the term. Repayment plans can include stock and share ISAs, pensions, investment bonds, shares, unit trusts, regular saving plans, and other properties or assets.

Some lenders offer a combined mortgage which allows you to use both interest-only and repayment loan methods to pay off the mortgage. However, some of the capital will still be owed at the end of the term, and will need to be paid off. Fixed vs Variable

The interest rate with which you make repayments can be fixed or variable.

A fixed interest rate will stay the same for the length of agreement. Fixed rate deals can last between 2-5 years, with some lasting as long as ten years. If the base rate of the Bank of England falls, borrowers won’t benefit from the lower rate, similarly if it rises, borrowers won’t have to pay the higher rate. Fixed rate mortgages may also include a charge for leaving the deal early, and borrowers may be put on a higher variable rate when the fixed term ends.

A variable interest rate can change with the Bank of England’s base rate or the lender’s decided rate. Variable rate deals may allow you to overpay or leave the deal at any time, and can come in different forms – discount, tracker, capped rate, or offset mortgages.

More on Mortgages

Mortgages come in many different forms and your offer can depend on an array of variables, such as your credit score, income, expenditure, and the details of the house you want to buy. Visit our Knowledge Centre for more information on mortgages.

This article was updated on 15 October 2020; all information was correct at the time of writing.

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