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How Does a Mortgage Work: A Guide For First-Time Buyers

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To try and help answer the question ‘how does a mortgage work?’ we’ve put together some first-time buyer advice

We’ve looked at everything from mortgages to help-to-buy schemes to help you better understand what costs are involved in buying a house.

How does a mortgage work

Whether you’re a first-time buyer or not, it’s likely you’ll need a mortgage in order to purchase your new home.

Our first tip is to speak to a mortgage adviser early on. They can explain the process and help you through each important step. A mortgage adviser will check what options are available and find the most appropriate deal for you.

Our recommended mortgage adviser offers fee-free advice in 24 hours and a decision on your mortgage in 5 days. Or they will pay you £100!

Mortgage Quotes

What is a mortgage?

A mortgage is a specific type of loan that relates to your home. A lender will pay a certain percentage of the overall cost of your home and this loan is ‘secured’ against the property.

This means that, if you fall behind in your payments or encounter financial difficulties, the lender has certain rights over your property.

How Much Could You Borrow?

How do I get a mortgage?

Many people will look at a comparison website or speak to their bank when it comes to getting a mortgage. Our advice would be to also speak to a Mortage Advisor who can advise on the type of borrowing that will suit you best. There’s a number of ways you can improve your chances of getting a mortgage.

What information will a lender consider?

A lender will want to be certain that you can afford your mortgage repayments both now and in the future, even if your circumstances change or interest rates rise.

Legislation now ensures that they take into account of all of your income and have details of all your outgoings.

Your mortgage criteria

There are different criteria they will consider to enable them to lend to many different sorts of people (i.e. the self-employed or retirees). However, ultimately, they will want to make sure that their money is safe.

Be prepared to fully reveal your financial circumstances to a lender or a mortgage broker, as this will enable them to give you the most accurate picture of how much money you could borrow.

Incoming Vs outgoing

Make sure you are aware of all your individual and household outgoings before beginning this process.

Also, be honest about any payment defaults or debts you may have, as it doesn’t always mean that you will be unable to get a mortgage. Calling in the experts in the form of a mortgage broker can be useful in terms of getting good, independent advice about the best options to suit your individual circumstances.

Different types of mortgage

There are two main types of mortgage loan structure: a repayment mortgage and an interest-only mortgage.

A repayment mortgage is a loan on which you pay the interest, plus a small portion of the capital sum back to the lender each month.

This means that the amount you have borrowed gradually decreases over the loan period.

Interest-only mortgages used to be very popular in the UK as they were more affordable (you only pay the interest each month). Property values were rising so fast that your equity in the property was likely to rise even without you paying off any of the debt secured against it.

The uncertainty of the modern-day property market means that interest-only loans are far rarer nowadays, as lenders are uncomfortable with borrowers having to repay the full loan amount in one hit at the end of the mortgage term.

If you do have an interest-only mortgage, a lender will want to see a savings programme in place to ensure that you have the funds to repay the loan.

Variable rate mortgage

This is a loan with a rate that could change at any time in line with broader economic factors.

This type of loan is popular when rates are low and predicted to stay that way.

Make sure you’re able to afford a higher rate on your loan before your commit to it.

Fixed rate mortgage

Lots of buyers opt for this type of mortgage as it offers them the security of ‘fixing’ their outgoings from month to month and even year to year. Many homeowners opt for a fixed term loan and then get a new mortgage when that initial fixed period expires. This is known as remortgaging.

Tracker mortgage

A tracker mortgage offers you a variable rate but one that moves in line with the Bank of England’s base rate for mortgages.

Choosing a variable rate is always a gamble, but a tracker can be a beneficial way to borrow your money.

Capped-rate mortgage

This is another form of variable rate loan but the interest rate has an upper limit. This allows for a low rate initially, but means you can predict what your maximum liability will be for a set amount of time.

This can be a useful mechanism if it looks like rates are likely to rise in the short term.

Discounted rate mortgage

This is a loan with an interest rate which is based on the lender’s basic rate and is therefore also variable. As a buyer, you will be granted a reduction in their standard rate for a period of one or two years.

Offset mortgage

This mortgage considers any savings you may have if you place them with your mortgage lender.

The result is that you will not earn interest on your savings but also won’t pay interest on the equivalent amount on your loan.

For example, if you have a mortgage of £300,000 and savings of £30,000 you only pay interest on £270,000.

How much interest will I pay?

The interest rate is what dictates how much money you will repay to a lender over and above the original loan amount.

Lenders usually set their rates in relation to the Bank of England base rate, so your rate is going to change over the period of the loan – its best to be cautious about this.

Lenders offer several different types of interest on their mortgages in order to suit your circumstances.

Mortgage Quotes

Getting help from your family

It is very common nowadays to get help from a family member towards the deposit amount, as property prices mean that saving to buy your first home can take years. A gift from family is, in theory, a great solution if you can’t afford your house outright

However, remember that misunderstandings about money can prove divisive to even the closest of family units. Make sure that both parties understand the terms of the loan before you finalise the agreement.  

If you don’t have a friend or family member who is happy to actively lend you the money, there are now mortgage products that allow them to guarantee your loan.

This means that they don’t have to hand you any money.

The mortgage company will be more likely to agree a loan if they know there are more funds available should you encounter financial problems.

Getting help from the government

Property prices have risen disproportionately in relation to most salaries, therefore many people struggle to get a foothold on the property ladder.

The government has put in place the help-to-buy scheme to help people get on the property ladder.

Help-to-buy

Help-to-buy is a government scheme to help people who are not able to pay for an entire property themselves.

Shared ownership

In the ‘Shared Ownership’ model you can buy a property via a housing association, but they retain ownership of a percentage of the property. You then pay rent on the percentage they own.

How do I qualify

You can enter into a shared ownership agreement to buy between 25% and 75% of a property if:

  • You are buying your first home
  • If you have previously owned a property but can no longer afford one
  • You are currently living in a shared ownership property

The scheme offers some flexibility – for example you can start with a 25% ownership and buy a greater share when you are able. There is a special scheme in place to help the over 55s.

When you sell your property, the housing association asks to have first refusal, i.e. you need to offer it to them first.

Affordability Calculator

Help-to-buy: Equity loan scheme

This low-interest loan is available to help you gather a larger deposit and therefore benefit from better mortgage options and lower monthly outgoings – it is called an equity loan.

You are eligible for this loan if you are:

  • buying a new build property from a registered Help to Buy builder
  • buying a property with a purchase price of up to £600,000 in England (or £300,000 in Wales)
  • only going to own this property (i.e. it can’t be a second home or rental investment)
  • not planning to sub-let or rent it out after you buy it
  • able to demonstrate that you can’t afford it (if you are buying in Wales)

How it works:

  • You supply a 5% deposit
  • The government will lend you up to a further 20% of the property (or 40% if you are in London)
  • You find a mortgage for the remaining amount – up to 75% (or 55% in London)

For example:

  • You collect the 5% deposit – i.e. £20,000 on a £400,000 purchase
  • The government lend you up to £80,000
  • You obtain a mortgage for the remainder £300,000

You have to pay fees on the loan but not for the first five years of ownership.

After that you make monthly payments equating to 1.75% of the loan in the first year. That rate rises in line with the Retail Price Index thereafter. These interest payments don’t count towards paying off any of the loan amount.

You only need to pay the loan back after 25 years or when you sell your home – whichever comes sooner.

If you repay the loan after you sell your home you will need to repay the % of the sale price that equates to the % you borrowed initially. For example, if you borrow 20% of a £400,00 purchase (£80,000) and sell for £500,000 you will need to repay £100,000.

Both of these schemes are designed to assist you if you can’t raise enough capital to buy the home you need. Make sure you do your research and seek advice before committing yourself to something like this.

You need to understand what your obligations are and what the downsides might be if/when you want to sell your property.

Need a mortgage?

We understand that buying a house can be tough!

Move iQ are here to help you navigate the process. You can save yourself a huge amount of wasted time researching the numerous mortgage products out there by talking directly to an experienced mortgage adviser. Our recommended mortgage advisers offer fee-free advice in 24 hours and a decision on your mortgage in 5 days. Or they will pay you £100!.

Mortgage Quotes

Your home may be repossessed if you do not keep up repayments on your mortgage. Terms and conditions apply to the mortgage decision promise.

Last Updated: April 7th, 2022

Phil Spencer

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