When buying a home, the financial side of things is often the most daunting aspect!
Many people want more than they can afford, and sometimes even the process of establishing how much money they have (or can borrow) is enough to deter prospective buyers.
To try and help answer the question ‘How does a mortgage work?’ we’ve put together a guide for first-time buyers mortgage 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 mortgages 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.
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 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 an Independent Financial Advisor (IFA) who can give you a ‘whole of the market’ opinion on what type of borrowing 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.
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 an IFA, as this will enable them to give you the most accurate picture of how much money you are entitled to.
Make sure you are aware of all your individual and household outgoings before beginning this process.
Also, be honest about any adverse credit history 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 an IFA 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 – which is typically 25 years, but could be longer depending on your age.
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. Whilst these loans are good for first-time buyers who don’t have much spare money at the outset, they do have their downsides.
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.
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 if rates are steady a tracker can be a beneficial way to borrow your money.
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.
This is a mortgage which is very attractive to those who need to buy a large amount of furniture or do refurbishment works to a property. These loans often have a slightly higher interest rate which the lender will use to fund the cashback offer.
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.
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. Help 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: Shared ownership
Help-to-buy is a government scheme to help people who are not able to pay for an entire property themselves.
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.
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)
- 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!
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