Whether you’re a first-time buyer or you’ve done this all before, buying a house is a huge undertaking. Understanding how mortgages work isn’t always simple, but we’ve compiled a handy guide that gives you an overview of everything you need to know.
After reading this guide, you’ll understand more about how mortgages work and what steps you need to take towards securing yours.
The information in this article has been sourced from information available in the public domain. You should take independent financial advice before entering into a mortgage or other investment product.
What is a mortgage?
Most people can't afford to buy a home outright, which means most property purchases involve the buyer borrowing money from a bank or building society.
Your mortgage deal will allow you to borrow a portion of the property value, which you'll pay back to the lender over the years of your mortgage term. The rest of the house price will be paid by you upfront, as your deposit. This is usually between 10% and 20% of the total house value.
Just like with other types of loan, borrowing money in the form of mortgage loans requires the borrower to pay interest. This interest forms part of your monthly mortgage payment.
How much interest you pay will depend on the size of your mortgage, the length of the repayment term and the interest rate you agree with the lender.
What steps do I need to take to secure a mortgage?
Buying a house can be daunting but we’ve broken down the key steps involved in securing your mortgage offer.
1. Work out your affordability
Your affordability is the total sum of your cash deposit and the mortgage you’re able to borrow. So, if a lender is willing to lend you £200,000 and you have £30,000 in your own savings account, your maximum house affordability will be £230,000.
How much you’re able to borrow will depend on your salary (or salaries, if you’re buying as a couple). However much you’re borrowing, you need to be confident you can make your mortgage payments each month. Borrowing within your means is essential.
A lender is likely to consider lending you between four and four and a half times your salary (or combined salaries if you’re buying as a couple). While it is possible to get a mortgage for five times your salary, this usually only applies to individuals with very high salaries.
Here are some figures to give you an idea of how much a lender might be willing to lend to you:
Number of people | Total salary | 4 times total salary | 4.5 times total salary |
|---|---|---|---|
1 x £30,000 salary (one buyer) | £30,000 | £120,000 | £135,000 |
2 x £30,000 salaries (two buyers) | £60,000 | £240,000 | £270,000 |
Getting a mortgage isn’t just about borrowing as much money as possible. You need to actually have the household income to make the monthly payments once you’re in your new home. Asking yourself what house price can I afford? is a crucial first step to take.
You can use a quick debt-to-income ratio (DTI ratio) to help you work out how much you can reasonably afford. This is one of the checks a lender will do before agreeing on your mortgage offer.
A DTI ratio is a way for a lender to see what your existing debt commitments are. This can be used to judge how much money you can afford to pay each month towards your mortgage, based on your other debt commitments.
So, how much of your income should go towards monthly mortgage repayments?
The general advice for DTI ratios is that you should aim to spend no more than 20% of your gross monthly income on your housing expenses (aka mortgage repayments).
If your debt ratio is 20% or below, you may be able to secure a better mortgage rate because you’re showing a lender you’re responsible when it comes to managing your money.
Having a high debt ratio is a worry for you as a homeowner as well. If all or most of your annual income is tied up in your home and mortgage, this is known as being ‘house poor’.
If you’re house poor, you’ll have fewer cash reserves and extra income to spend on things outside of your home, such as savings for emergencies or holidays.
Without this comfortable cushion of savings, you’ll be unprepared for emergencies and less able to enjoy activities like travelling.
2. Get your house deposit together
Before you can buy a house, you’ll need to have enough savings to cover a percentage of the property purchase price. This will make up your deposit.
The more cash you can put down on your house, the less you’ll need to borrow from a lender. So, if you can put a bigger deposit down, you’ll own more of the property from the outset. You might have heard this referred to as a loan-to-value (LTV) ratio.
Lenders are more likely to accept mortgage applications from applicants with lower LTV ratios.
Loan to Value (LTV) ratio
The value of your existing loan as a percentage of the total value of the property you have purchased.
If you have £25,000 to put down against a £250,000 house, you’ll be borrowing £225,000. This is 90% of the total property value, so your LTV ratio is 90%.
3. Optimise your savings
If you’re not looking to purchase a house immediately, it could be worth opening a dedicated savings account to keep your deposit in.
If you’re prepared to lock your savings in for six months or a year (or more), you might want to consider a fixed-term savings account. With a fixed rate account, you’ll be able to maximise your savings with a fixed agreed interest rate, which will often be higher than a standard savings account or current account interest rate.
Make sure you look around for the best fixed-term or flexible savings account deal, as it’s not necessarily the case that your current bank will offer the best interest rate.
If you’re a first time buyer and you’re not planning to buy your first home for at least a year, you could put your deposit savings into a Lifetime ISA (LISA).
As long as you’re between the ages of 18 and 40 and you’ve never bought a property before, you can take advantage of a 25% government bonus on your savings.
You can put up to £4,000 into your LISA every tax year, with the government bonus taking your total up to £5,000 when you invest £4,000. You don’t pay tax on any of the interest your savings earn.
It’s important to do your research to work out:
- Whether a LISA is the best option for you
- Which LISA provider to go with
4. Improve your credit score
When you get to the stage where you’re speaking to a mortgage broker/adviser or contacting mortgage providers yourself, they will want to know if you have any outstanding debts.
This includes personal credit cards and outstanding loans but also any finance arrangements you have, such as car finance or a mobile phone contract.
Having personal debt is likely to have an impact on how much you could borrow for your mortgage.
If your debt isn’t significant, you could try to pay it off before getting your mortgage in principle agreed. Paying off any debt you owe will improve your credit rating and show a mortgage lender they can trust you to pay back what you borrow.
At the very least, make sure you’re sticking to your monthly repayments to show you’re a responsible borrower. Any defaults on credit cards will be very unappealing to a lender.
If you do have a bad credit history due to defaulting on debt payments, previous repossessions, bankruptcy or mortgage arrears, there are still options available to you.
You may be able to get accepted for a bad credit mortgage, but it’s worth speaking to a mortgage broker to help you with this. The rate you’ll be charged will be much higher and you probably won’t be able to borrow as much.
5. Get mortgage advice and a decision in principle from an expert mortgage broker
It's vital that you do research into which bank or building society can offer you offer you the best mortgage rate. A broker or financial adviser can help you do this.
A mortgage adviser or broker is an independent professional with a wide knowledge of the house market, mortgage rates and different lenders.
They can compare mortgages for you, before presenting you with the best deal to suit your personal and financial situation. In short, they can help you answer the important question of how much can I borrow?
You’ll sometimes hear them referred to as mortgage advisers and other times mortgage brokers. There’s no real difference between these two terms and they are used interchangeably.
How much will a mortgage broker cost?
There are plenty of fee-free mortgage brokers, meaning you can get financial advice from a mortgage professional without spending a penny.
Mortgage brokers get paid by commission from the lender, which means most won’t charge you a fee. Make sure you check with your broker whether they charge a fee before hiring them.
Getting advice from a fee-free mortgage broker will help you get a much clearer picture of what kind of property you can afford to buy.
Finding the best mortgage broker
When it comes to finding a mortgage broker, your best bet is to go by recommendation from someone you trust. In fact, many mortgage brokers only accept clients who have been recommended to them.
You could also check out the Mortgage Advice Bureau, where you can choose a financial adviser from their 2,000+ advisers across the UK.
Some mortgage brokers have affiliations with certain mortgage providers. These are referred to as ‘tied’ brokers, and they’ll only be able to provide you with deals from a limited number of lenders.
This means they might not come up with the best mortgage deals for you, so you’ll want to consider this when choosing your mortgage broker. An independent broker will be able to come up with offers from more providers, making it more likely you’ll get the best deal.
What does an expert mortgage broker do?
Your mortgage broker will be able to give you free mortgage advice, as well as carry out an affordability assessment on your behalf. They’ll ask you for some basic information about your finances, such as whether you have any outstanding credit cards or car finance repayments.
You’ll also need to tell them your annual salary, as well as where you work, how long you’ve worked there and how much cash you have saved for your deposit.
This information will enable them to give you a pretty accurate estimate of how much money you’ll most likely be able to borrow. A mortgage broker will use this information to provide you with a decision in principle.
What is a decision in principle?
A decision in principle (DIP) is an unofficial agreement between a lender and borrower. The lender is agreeing that if everything you’ve told them about your salary and financial situation checks out, they’ll lend you x amount of money.
A decision in principle might also be referred to as a mortgage in principle, an agreement in principle or approval in principle. Depending on the lender, decisions in principle tend to be valid for between 30 and 90 days.
You’ll need a mortgage decision in principle as proof you can afford a property and you’re unlikely to get an offer on a property accepted without one.
Your DIP is a guide to how much you can afford to spend on a house. This is the total figure you’re likely to be able to borrow from a lender. It does not include your cash deposit, so you can add your deposit to the figure in your DIP agreement to see what total property price you can afford.
A DIP is not a guarantee. You'll need to prove your affordability by providing recent payslips and bank statements before you're able to secure a final offer.
Can I apply for a mortgage online myself?
If you don’t want to go through a mortgage broker, you can apply online for a mortgage instead. However, you might not get access to the best deals on the market without the help of a broker.
If you do a search online for a free mortgage calculator tool, you can get a rough idea of what you can afford to borrow.
Most mortgage calculators will ask you questions about your annual gross income, as well as your monthly income after tax and National Insurance deductions, pension payments and any other fees are taken into account. You’ll also be asked about any additional income.
Even if you choose to go through a broker rather than apply online for yourself, mortgage calculators are a great way to get an estimate of what you’ll be able to borrow.
While it might seem easier to submit your own mortgage application online, doing so might reduce your chance of getting the best deal. This is because mortgage brokers have access to mortgages not available on the wider market.
They’re literally mortgage experts, and they usually don’t ask for a fee, so you might as well seek out their help. If you’re looking to get more information about a certain lender, the Financial Conduct Authority has lots of information for you to look through.
6. Secure your mortgage offer
In order to get your official mortgage offer, you’ll need to be able to provide proof of your identity and income. These mortgage affordability checks will give the lender proof that you meet their mortgage lending criteria.
Alongside your passport or driver’s licence, you’ll need to submit up to six months of bank statements and three months of payslips from your current employer. You’ll also probably need to provide some utility bills from your current address unless you don’t currently pay for them.
This stage will involve having a credit check run on your behalf, which involves looking at any past or present credit card debts. If the lender is doing a hard check on your credit history (which is very common if you’re a first-time buyer), this will likely have an effect on your credit score.
Because of this, it’s important you try not to let your mortgage offer expire. Multiple hard credit checks leave ‘footprints’ on your credit record.
These can give the impression you’re struggling to get a mortgage from a lender, which will make other lenders less likely to want to lend you money. If your mortgage offer is in danger of expiring, see if you can get an extension.
Securing your mortgage if you're self-employed
The process of affordability checks is different if you’re self-employed. You’ll need to provide evidence of your self-assessment tax returns for the last two years (your SA302 summary), as well as your tax year overview from HMRC for those years.
The lender may also want to see the last two years’ worth of certified accounts, which you’ll probably need to enlist the help of an accountant for. Don’t worry if you’ve been self-employed for less than two years; there are still lenders who can help you out.
7. Get to grips with your mortgage term, repayments and interest rates
How much you pay each month for your home's mortgage depends on your mortgage loan term, your repayment agreement and interest rates.
What is a mortgage term?
A mortgage term is the number of years it’ll take you to repay your mortgage.
Lenders generally give longer mortgage terms to younger people, simply because there’s a higher likelihood they’ll live long enough and be earning money for long enough to pay the entire mortgage off.
Most lenders will want to ensure your term will end before you retire. At this point, your likelihood of a decrease in income and your overall health will become more probable.
If you have a longer term, your mortgage total will be spread out over a longer period of time. This means your monthly repayments will be smaller.
The average mortgage term is 25 years, but this can be stretched up to 40 years in some cases. Bear in mind that while a longer mortgage term means you’ll pay less each month, you’ll pay more interest over the course of your term.
How do repayment mortgages work?
The way repayment mortgages work is that you repay your mortgage loan in fixed monthly instalments for an agreed mortgage term.
As you’ll be paying off the amount you borrow over the course of your term, you’ll pay more interest in the earlier years of your mortgage, and less as the figure you owe decreases.
As your interest payments decrease, you’ll pay more off the outstanding balance. You’ll always be paying the same each month (unless you switch your mortgage interest rate), but how this figure is made up will vary over the years.
In the beginning, you’ll be paying more interest and less capital repayment (i.e. the loan itself), and you’ll pay less interest and more capital repayment towards the end.
You should make sure you understand your mortgage lender’s rules regarding making overpayments and early repayments before you confirm your mortgage agreement. If you get a pay rise or come into some money, you might want to either increase your monthly mortgage repayments or pay off a lump sum.
Doing this will reduce the amount of interest you pay overall because you’ll be borrowing less money as a result of paying more of your mortgage off.
Variable and fixed interest rates explained
With a variable-rate mortgage, your initial interest rate isn’t a permanent agreement. This means your monthly mortgage rate will change over time (in fact, it can change at any time).
There are two main types of variable rate mortgages: tracker mortgages and standard variable rate mortgages (SVRs).
A tracker mortgage is a mortgage that tracks the Bank of England base rate, whereas an SVR tracks the rate of the bank you took the mortgage out with. If you take out a tracker mortgage, your interest rate will go up and down with any Bank of England interest rate change.
However, if you go for an SVR, your rate is decided by your lender. When mortgage interest rates increase, your overall mortgage payment will increase proportionally.
You should make sure you have enough leeway with your finances so you have a comfortable cushion to support you should rates rise by up to 3% (this is known as a stress test).
However, you can also choose to fix your interest payments for a set amount of time for a fee. This is known as a fixed-rate mortgage. With this type of mortgage agreement, your monthly payments won’t go up or down as they would if you were on a variable rate.
You can fix your mortgage for between one and 15 years, although most borrowers opt for a two, three or five-year fixed mortgage.
You’ll probably have to pay an upfront fee if you’re taking out a fixed-rate mortgage, which could cost you between £1,000 and £2,000. But with the amount of money you could save, this is a sensible option to consider (particularly in times of economic instability).
The best mortgages for first-time buyers
There are often schemes designed to help first time buyers get onto the property ladder. These are frequently changing, so it’s worth doing a bit of research into what’s available at the time you’re hoping to buy.
There is currently a First Homes government initiative allowing some first time buyers to buy a home for between 30% and 50% less than its market value.
Past schemes have included the Help to Buy equity loan scheme, where you could have applied for a government loan of up to 20% of the property value. First-time buyers only needed to provide a 5% deposit and the 20% government equity loan would have made up the rest of their deposit. This loan remained interest-free for the first five years.
8. Be prepared for other fees
Depending on the type of property you’re buying, you may need to pay for some or all of the following things.
Firstly, keep aside up to £1,500 to pay your legal fees (this will be higher if you're selling an existing property).
You may need to pay a valuation fee so the lender can ensure the property is worth what you’re going to be paying for it (although these surveys are often free of charge).
You’ll also need to pay to have a home survey or snagging survey conducted on the property. This will give you an overview of the property’s overall condition and highlight any significant issues with the structure or condition.
House surveys start from as little as £300, depending on the age and condition of your property, as well as the level of detail you want or need the report to go into. More in-depth home surveys can cost as much as £1,500.
Snagging surveys are for spotting issues with new build homes. A snagging surveyor will check the property for issues or defects with the build, known as 'snags'. These typically start from around £300 and shouldn’t cost you more than £600.
Your mortgage lender will also most likely require you to take out buildings insurance as part of your mortgage agreement). Other types of financial protection you should consider include life insurance, critical illness cover and some form of income protection in case you're unable to work for any reason in the future and need help paying your mortgage.
Your broker should be able to provide you with insurance quotes, although you can arrange this yourself if you'd prefer.
You’ll also need to take into account stamp duty and other land and property taxes, if applicable to you, as well as other general costs of moving home (like removal van fees).
Get your foot on the property ladder today
Let’s face it, mortgage applications are long, complicated and emotionally taxing. But you’re not alone. Getting a clearer idea of your financial situation and working out the maximum mortgage you can afford is a big part of the battle.
The more information you have, the more prepared you’ll be when it comes to buying your property. Use an affordability calculator online, speak to your friends and family who’ve bought a home in the past, and don’t be scared to seek out financial support and advice if you need it — it's often free.
If you find yourself struggling with money worries or debt payments, there’s extra financial support available.
Places like Shelter, National Debtline and StepChange all offer free debt advice. You could also use a free budget planner (such as the government’s Money Helper budget planner) to help keep track of your monthly spending.
The information in this article has been sourced from information available in the public domain. You should take independent financial advice before entering into a mortgage or other investment product.