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How getting the most appropriate residential mortgage means paying less for your home
Residential mortgages may seem simple - everyone has one - but they can be a minefield to the uninitiated. There are many different types available, so it's essential that when you apply for a mortgage, you do so feeling confident that you have made an informed choice. We also look at the different types of borrower to help you get an understanding of how lenders might view you!
What is a mortgage
A residential mortgage is a large, long-term loan taken out by one or more individuals to buy a home to live in.
A residential mortgage is secured against the home being bought. This means that if repayments are consistently not met and a borrower defaults on paying the mortgage, the lender has a claim on the home. To recoup the money lent, the lender may evict the residents and sell the house, using the income from the sale to clear the mortgage debt. This is known as foreclosure and is usually the final resort.
If you are concerned about defaulting on a mortgage read our managing debt guide for more information.
Whether you are a first-time buyer, moving home or remortgaging, you will need a residential mortgage but although all mortgages work on the same principle - they are a large-scale, long-term loan secured on the property you are buying - there are actually many different types of mortgage to consider.
A mortgage is a long-term commitment. It may take 25 years - or these days, 30 or even 40 years - to pay off with regular monthly repayments. But there are different ways of dealing with that commitment, depending on your circumstances.
There are two types of repayments:
Capital and interest
With Capital and interest mortgages - also known as repayment mortgages - each month you pay interest to the lender and also a small amount of capital. This means that month on month, the amount you owe reduces until eventually the debt is repaid. The duration over which you pay the mortgage back can be 35 years or more, subject to the mortgage ending, generally speaking, before your 70th birthday.
With interest-only, each month you pay only interest to the lender, meaning that the amount you actually owe does not reduce.
To ensure that you can repay the mortgage at the end of the term, lenders are keen to understand your long-term plans. Acceptable options include the sale of the property, pension lump sums, endowments and savings. Interest-only mortgages are now harder to obtain than repayment mortgages and eligibility for them is complex.
There are also several types of interest scheme:
Standard Variable Rate
With a Standard Variable Rate, you will be paying the standard rate charged by your lender. This will vary with bank rate and the state of the economy and may be much higher than other mortgage deals available, and most borrowers will arrange a mortgage based on one of the rates available.
Other types of variable mortgage are available, where your interest rates will vary at the discretion of the lender. This means that the cost of your mortgage could be increased from the initial rate. However, this is unlikely to be too severe or sudden as a mixture of competition and fear of bad publicity tends to stop variable mortgages hiking up to a high rate. Remember, you will always have the choice of switching to a better deal
There are several introductory interest arrangements that you might want to consider, and the fixed-rate mortgage is one of the most popular. With a fixed-rate mortgage, the rate of interest you will pay is set for a period of time. Most lenders offer rates that are fixed for 2, 3 and 5 years, although some also offer 1 and 10-year rates. Irrespective of what the Bank of England Base rate and LIBOR are doing, your interest rate will remain the same for this period of time. Once your fixed rate finishes, you will move onto the lender's Standard Variable Rate and, at this point, borrowers will look to secure a new deal either with the same lender or with a remortgage to a new provider. They can be very beneficial if interest rates rise significantly as your repayments will not become more expensive, but you will not benefit from falling interest rates.
A tracker mortgage has a rate that tracks the Bank of England Base Rate or LIBOR, with a set percentage difference - such as 2%. The key here is that these rates are subject to change and can move up or down with the bank rate. You can take out a deal that tracks for 2, 3 or 5 years and then moves onto the lender's Standard Variable Rate, or you may be able to take a product where it tracks for the full term of the mortgage.
Discounted rate mortgage
Another similar offer is a discounted rate mortgage. This is where the lender is providing you with a set discount from their Standard Variable Rate. As with trackers, it is subject to movement and can be for a period of 2, 3 or 5 years, for the term of the mortgage.
An Offset mortgage - or current account mortgage - uses the money you have in your bank account to help you save on your mortgage payments. The more money you have in your savings, the more you save on your mortgage payments. Instead of receiving interest on your cash on deposit, it will be used to reduce the mortgage balance on which you are charged interest. The great thing with an offset mortgage is that you can reduce your monthly mortgage payments or your mortgage term whilst still having instant access to your savings if you need them.
A capped rate mortgage is a variable rate mortgage, usually a tracker or a discounted rate, but which has the safety net of a maximum rate of interest. For example, if the rate was capped at 5%, as long as the interest you were paying was below this amount, it can go up and down but it could not go over 5%, irrespective of rate movements. Again, the capped rate would be in place for 2, 3 or 5 years before going back onto the lender's standard variable rate.
A cashback mortgage normally gives you a lump sum cash amount when your mortgage begins - so that you may be borrowing more than the sum you require to buy your home. This can be particularly helpful for first-time buyers, who can face significant costs setting up their new home. Cashback incentives only apply to certain mortgages and may be a fixed amount or a percentage of the total. The disadvantage of a cashback mortgage is that the interest rate is normally higher than average - and you will be paying interest on the extra sum for many years to come.
A remortgage is a common process for mortgage holders and is when a new mortgage is taken out without moving home. Homeowners remortgage for a variety of reasons including:
- To move to a better mortgage rate - this is often possible at the end of a fixed rate or similar introductory period
- To release equity from a property - the constant increase in the value of residential property means that your home may be a source of wealth that you can use elsewhere. Using your investment in your home to buy other property, for example, may be possible with a suitable remortgage
- To consolidate debts - your home may provide a tempting source of funds, especially if it has grown in value. However, when consolidating debts the funds will be repaid over the term of the mortgage, therefore the overall cost of repaying the loan is likely to be higher as the term of the loan is longer.
Most residential mortgage products are available for homeowners looking to remortgage, they are not usually different products. Remortgages can normally be arranged with any type of mortgage.
Almost all Residential lenders require a cash deposit, typically between 10-30% of a home’s market value.
For example, a mortgage for a £300,000 home would require an upfront deposit of anything between £30,000 and £90,000.
Some residential lenders may ask for less than a 10% deposit to entice first-time buyers, and the government’s Help to Buy Scheme means those who qualify only need to stump up as little as 5% of the value of your home.
Loan to value ratio (LTV)
Your loan to value is the amount you need to borrow, as a ration set against the value of the property.
If you have a deposit of £80,000, you will need to borrow £320,000 to be able to afford a £400,000 property. Borrowing £320,000 for a £400,000 home gives you an 80% loan to value ratio, with your £80,000 deposit accounting for the remaining 20%.
Loan to value ratios of 80% and lower are typically seen as low LTV ratios, while LTVs over 90% are considered higher. The lower the ratio, the smaller the risk for the lender and the better the interest rates likely to be offered to the borrower.
The best rates come with 60% LTV mortgages which are the lowest available LTV mortgages.
95% LTV mortgages, 90% LTV mortgages and 85% LTV mortgages are all at the high end of available LTVs. These may have much higher interest rates, but offer a way for first-time buyers to buy a home.
The highest LTV you can is with a 100% LTV mortgage but these are now very rare. They require no deposit but often charge very high rates of interest and require guarantors.
Whatever type of mortgage you choose, there will be monthly repayments that will need to be made until the mortgage is repaid. Not being able to meet these repayments could result in losing your home. These repayments will increase or decrease with the amount of interest being charged.
The repayment schedule on a typical residential mortgage used to around 25 years, but the high cost of property means that much longer terms are now available, and 40 years arrangements are possible. The longer the repayment schedule, the smaller the monthly repayments and vice versa. You can remortgage if your circumstances have changed and you want to pay back the debt faster or slower.
However, many lenders have an upper age limit of 75 at the end of the mortgage agreement. So, for example, a 65-year-old would typically have to agree to repay a mortgage within 10 years.
How much can you borrow?
Your income is key to how much a mortgage provider is willing to lend. The more you earn, the more you can afford to repay each month, hence the more you can borrow, so the lender will require you to prove your declared income with payslips or other official documents.
Traditionally the size of a mortgage is decided by applying a multiplier to income, for example, if you earned £25,000 a year, a lender might multiply this figure by four (it's rare to multiply income by more than this) to arrive at a mortgage offer of £100,000.
If your household has two incomes these are typically be combined together in one of two ways.
- Add the lowest income on top of the highest after it has been multiplied. So if the highest income was £30,000 and the lowest was £20,000, the offer could be £140,000 (£30,000 x 4 + £20,000 = £140,000).
- Add both incomes together and use a lower multiplier figure. So for the same incomes this could result in an offer of £150,000 (£30,000 + £20,000 x 3 = £150,000).
Lenders tend to use whichever method results in the higher figure.
Your credit score is also very important in determining your eligibility for any borrowing, and mortgages are no exception. All providers will thoroughly examine your credit report and make their decision based on your score.
Checking your credit report is advisable before applying for a mortgage, as you can check for errors and correct any you may find. If you have a poor credit score you can also discover the cause and take steps to improve your credit score
What is a guarantor mortgage?
For many people, building up a sufficient deposit to buy their first home can be difficult. A guarantor mortgage can be the solution. With a guarantor mortgage, a parent or close family member takes on some of the risk of the mortgage by acting as a guarantor. This usually involves them offering their home or savings as security against the loan and agreeing to cover the mortgage payments if the homeowner defaults on repayments. Some guarantor mortgages even allow you to borrow 100% of the property's value by using your parent's collateral in place of a deposit. On the plus side, guarantor deals might help you get a mortgage or allow you to borrow more. The main downside is that the guarantor could be liable for any shortfall if your property has to be repossessed and sold.
Buying a home with a bad credit score
A good credit score is valuable when borrowing but if you have a poor credit score and you’re thinking about buying a home, there are mortgages available.
Whether you've missed a few credit card payments, had a County Court Judgment awarded against you or have previously been made bankrupt, there are lots of reasons you might be left with a bad credit rating.
Strictly speaking, bad credit mortgages don't exist - they are simply standard mortgages certain lenders offer to people who may fail credit checks elsewhere.
Mortgages of this kind used to be known as sub-prime mortgages. Now they are more commonly called adverse credit mortgages and are designed to help people with poor credit histories get on the property ladder.
Bad credit mortgage rates and charges tend to be higher, as lenders deem people with poor credit ratings to be a higher risk.
But paying back a mortgage for poor credit on time should help to 'repair' your credit rating, so you can move to a standard mortgage at a lower rate.
Property Finance from Rangewell
At Rangewell, we work with lenders across the market and have access to the full range of property funding products. It lets us use our property finance expertise to support your plans – and ensure that you have the financial solutions you need.
If you want help to buy your home, call us now.
ANY PROPERTY USED AS SECURITY, WHICH MAY INCLUDE YOUR HOME, MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE.
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