With hundreds on the market, mortgages can feel like a bit of a minefield. This guide aims to simplify them by introducing their various aspects in detail.
After reading, you’ll understand what types of mortgage are available, as well as their relative benefits and drawbacks. Being equipped with this information will make the selection and application process more painless.
Here’s what this guide covers:
- The definition of a mortgage
- Types of mortgage
- Fixed rate
- Variable rate
- No deposit
- Information on the application process
- How to find a mortgage
What is a mortgage and why do you need one?
A mortgage is a loan to help you meet the cost of buying a home.
In April 2018, the average UK house price was £226,906 (source, the UK House Price Index). This is way above funds most people have access to, so many people take out a mortgage to cover the shortfall.
In this guide you’ll see the term LTV fairly often. This stands for "loan to value", and shows the proportion of a property’s price represented by a mortgage.
If you have a 15% deposit and borrow the remaining 85% as a mortgage, you have an 85% LTV rate.
What types of mortgage are available?
There are two main types of mortgage: fixed rate and variable rate. The names are fairly self-explanatory, but we’ll introduce them anyway.
The rate of interest you pay will stay the same with a fixed rate mortgage, but will change in a variable rate one.
In a Standard Variable Rate (SVR) mortgage, interest varies but will usually be guided by the Bank of England base rate.
Tracker mortgages directly follow another interest rate, usually the Bank of England base rate.
A discount rate mortgage offers a discount on a lender’s SVR for an agreed period. Capped rate mortgages follow a lender’s SVR, but may not rise past an agreed cap.
With an offset mortgage your current and savings accounts are linked to the mortgage; you only pay interest on the remainder of your mortgage minus the balance in your account(s).
With hundreds on the market, mortgages can feel like a bit of a minefield. Our article: Types of Mortgages: The Ultimate Guide aims to simplify them by introducing their various aspects in detail..
No deposit mortgages
With a no deposit mortgage, you don’t need to save for a deposit. This sounds appealing for many reasons, but make sure you are very familiar with the risks if you even manage to find such a deal.
Can you still get a no deposit mortgage?
Yes, although they are much rarer than they were before the credit crunch.
In 2008, no deposit mortgages were removed from the market. They have recently made a comeback in a slightly different form: the 100% LTV mortgage.
A 100% LTV mortgage the amount borrowed covers the entire cost of the property. You may also come across the terms ‘mortgages with no money down’ and ‘no deposit mortgages’.
Benefits of a no deposit mortgage
By definition, no deposit is needed with a 100% LTV mortgage as you are borrowing the entire amount. This can help speed up the moving process because you don’t need to spend time saving for a deposit.
This type of mortgage can help mortgage prisoners to move or remortgage, allowing them to keep climbing the property ladder. Take as an example people who bought their house during a boom and are now experiencing negative equity because the value of their house has dropped below the outstanding mortgage to be repaid: a 100% LTV mortgage could help them toward a stronger position.
Drawbacks of a no deposit mortgage
Not having to save for a deposit does not necessarily save you money in the long run. Interest must be paid on the entire loan, meaning the total amount of interest repaid will be higher than lower LTV mortgages.
Base interest rates may also be higher on 100% LTV mortgages because of the inherent risk they present to lenders.
100% LTV mortgages are comparatively rare. Lenders take steps to protect themselves from the extra risk they represent, with some banks and building societies limiting these mortgages to people who borrow with them already; and others only releasing them in very small batches to curtail the risk.
You may also have to pay a mortgage indemnity fee, which further lowers the lender's risk but is often paid for by the borrower.
Some lenders will restrict applicants for 100% LTV mortgages to those with a guarantor, to ensure their risk is minimised. A guarantor is a person, usually a family member, who puts collateral against your mortgage and makes a legal commitment to cover your missed payments. This collateral will either be money (“savings as security”) or their property (“property as security”).
Finally, you are at higher risk of entering negative equity if the value of your home drops below your outstanding amount to be repaid. This is especially problematic if a situation arises where the bank tries to repossess your property and the money in the property is not enough to pay your debts.
Everybody needs a helping hand sometimes. Guarantor mortgages are a great way to get a step up onto the property ladder.
What is a guarantor mortgage?
With a guarantor mortgage, someone close to the borrower offers to take responsibility for some of the cost and risk of a property. They make a legally binding agreement to make repayments on your behalf if you are unable to.
Collateral is placed against the mortgage to ensure the lender will be able to recoup lost funds, usually in the form of the guarantor’s home (property as security). Some lenders accept a lump sum of cash instead (savings as security), which is kept in a dedicated savings account for an agreed period of time or until an agreed proportion of the mortgage has been repaid.
As a result, lenders are willing to give mortgage deals with better terms than what the borrower would otherwise have access to. As we mentioned earlier, some lenders will offer mortgages of 100% of the property value, meaning a deposit is not required.
The guarantor is not the owner of the property (neither full or partial) and they are not named on the property’s title deeds.
Most of the other aspects of the mortgage are the same. You will be required to make repayments, pay interest, and pay various fees including (but not limited to) mortgage, valuation, legal, and advisor fees.
If a guarantor passes away, you may be required to add another guarantor to your mortgage or allow their estate to repay the required amount.
Who is a guarantor mortgage suitable for?
Guarantor mortgages are popular among first-time buyers, as they reduce the difficulty associated with getting onto the property ladder. They can give access to properties that are bigger and more costly than what the buyer may otherwise have access to.
They are also suitable for borrowers with no deposit, low income, poor credit, or a combination of these factors.
Who can be a guarantor?
Guarantor mortgages are popular for parents helping their child to buy a home or to climb the property ladder.
Some lenders restrict who can be a guarantor for a mortgage, often to parents, step-parents and grandparents. This may vary between mortgage lenders so be sure to ask.
The maximum eligible age for a guarantor is 75. This is to ensure they are likely to be around for a significant amount of the mortgage term.
Often a guarantor will be required to own their property outright or to own a significant share, although this will vary by lender.
Lenders are also likely to require guarantors to have a high income, good credit rating, and to have sought legal advice during the process to demonstrate they understand the process sufficiently.
Generally a person can only be guarantor for one mortgage at a time: this is worth knowing as it has implications for a parent with more than one child.
What happens if a payment is missed?
In the first instance it is likely the lender will notify you that a payment has been missed, and give you more time to rectify the situation.
If payment is not made or payments are frequently missed, the following things may happen:
- The guarantor will be asked to cover the missed payment(s).
- The period of time before the guarantor can withdraw from the agreement may be extended.
- Repayment may be taken from the guarantor’s lump sum in the lender’s account.
- Your house may be repossessed.
- The guarantor’s home may be repossessed.
The items at the bottom of the list are unlikely unless things get drastic. Get more advice about paying off mortgages here.
Buying a house together is a big step, with several benefits. Here we explore types of joint ownership, and the pros and cons.
What is a joint mortgage
Joint ownership is suitable for partners, whether married, in a civil partnership or unmarried; however, it’s not limited to couples. Parents, family, friends and even business partners can benefit.
Up to 4 people can share legal ownership, with mortgages being incrementally harder to find as the number increases. The income of the top 2 applicants is usually taken into account.
You will either be a joint tenant or tenants in common. Each has implications for distribution of equity and ownership, inheritance, legal rights, and other factors, all outlined below.
What does it mean to be a joint tenant?
All joint tenants are legally considered as single owners with equal rights in the equity and ownership of the property.
Tenants cannot act separately: decisions to move, sell, or remortgage must be agreed by everyone. Tenants are free to leave but cannot force other tenants to do so; joint tenants have a legal right to stay in their property unless a court order declares otherwise.
On sale of the property, profits are distributed equally amongst former tenants.
In the case of a tenant’s death, the other(s) inherit their share of the property. This overrides wishes made in a will to the contrary; make sure this is understood when moving.
What does it mean to be tenants in common?
Joint tenants share equity and ownership but not necessarily equally. A deed of trust document will be signed by tenants before moving in, agreeing the percentage distributions.
Tenants can decide to sell or remortgage their portion of the property independently of the other(s), although this may lead to friction!
A tenant can be bought out of their share of the property by the other(s), meaning the property does not need to be sold before an owner can cash out and move on.
In the case of a tenant’s death, their share can be passed on as they wish.
Benefits of a joint mortgage
By combining incomes and savings you have access to more finance, which can be put toward deposit, fees, repayments, and other moving costs.
Because joint ownerships are not restricted to couples, they present more options to get on the property ladder.
A joint mortgage does not restrict your ability to apply to government schemes.
Potential drawbacks of a joint mortgage
Despite good intentions, it’s hard to predict how relationships between tenants will unfold. Married couples sometimes divorce; friends drift apart, move on, or even fall out.
While legally binding cohabitation documents can be signed at the outset (recommended!), emotional and legal implications remain if a tenant decides to leave. This depends on the ownership structure, as outlined above.
When applying, other applicants’ negative credit ratings can impact the likelihood of acceptance.
Tenants are considered “jointly and severally liable” for mortgage repayments, so if someone stops paying, their payments must be made up by the other tenant(s).
Things to consider
Sit down and talk to who you are planning to move in with, and make sure you are all in agreement. Buying a house together is a big commitment, and agreements made at this stage can make or break the experience.
Get legally binding documents outlining the terms of the joint ownership, to refer to if things go south.
You can change between being joint tenants or tenants in common if circumstances change. The government charge no fee for this.
This type of mortgage can seem confusing at first, but it’s worth getting familiar with as it represents a nice middle ground between some other options.
What is an offset mortgage?
An offset mortgage is a type of mortgage linked to one, or more, savings account. The balance of the linked account(s) is used to either reduce your monthly repayments or your mortgage term.
How does an offset mortgage work?
You pay interest on the balance of your mortgage minus the balance of your savings account(s). You usually won’t earn interest on your savings, instead opting to save money on your mortgage interest repayments.
In most offset mortgages, only the interest payments take your savings balance into account. Repayments on the mortgage itself will most likely be calculated on the full amount. It is worth asking your lender about this, as it will vary.
Benefits of an offset mortgage
Offset mortgages reflect a good balance between getting the most cost-effective mortgage deal and having access to a nest egg in case your financial circumstances change.
With a traditional mortgage you can make overpayments if you have more money than usual, but if things change again and you find yourself feeling the pinch, you can no longer access this overpaid money.
With an offset mortgage this problem is avoided as you have unrestricted access to the money in your savings account(s), although be aware that some lenders stipulate a minimum savings balance. You can withdraw money when needed, but keep in mind this will reduce the amount you save on interest repayments.
You are also able to add to the savings balance, further reducing the amount you pay in interest.
In most cases, you will save more money on interest repayments than you would earn from interest on the equivalent savings amount. An example is shown at the end of this guide. You also avoid paying any tax that would’ve been due on personal savings.
Used correctly, an offset mortgage can reduce monthly repayments or your mortgage term. We would usually recommend the latter if possible.
Who is an offset mortgage suitable for?
In our experience, offset mortgages are less popular among first-time buyers. They represent a relatively small section of the mortgage market, although they are increasing in popularity over the past few years.
We also see parents who want to give financial help to their children recommending offset mortgages, as their savings account can be linked to their child’s mortgage. This allows financial support without actually handing over a lump sum of money.
An offset mortgage example
This example uses simplified figures, but gives a general idea of how an offset mortgage could save you money.
- Say you had a £150,000 mortgage and £30,000 savings.
- You would pay interest on £120,000: the balance of the mortgage minus the balance of the savings.
- With a 3% rate this would cost you £3,600 in interest per year, rather than £4,500.
- If you previously had 1% interest on your savings account, you would miss out on £300 of savings interest.
- Overall, you pay £3,600 instead of paying £4,500 while missing out on £300, meaning you’re £600 better off at the end of the year.
Mortgages if you’re self-employed
Contrary to belief, there are no special types of self-employed mortgage. You will be in the market for the same products as other applicants.
Confusion arises from self-certification mortgages, which were banned in 2011 by the Financial Conduct Authority. These allowed people to certify their ability to repay rather than to prove it, and were thus favoured by the self-employed because they removed the need to demonstrate potentially-sporadic earnings.
Other things to know
Once you’re familiar with the types of mortgage available, it’s time to get familiar with the application process. This section of the guide explores various aspects of applying for a mortgage.
How do you apply for a mortgage?
You will be given a Key Facts Illustration (KFI) for each mortgage you’re interested in, which outlines the exact terms.
When you find one you like, you state an agreement in principle to indicate your interest.
At this point the lender will ask for required information, and the application process will begin. This is where the paperwork begins!
How to work out what you can afford
When you’ve decided to buy a home, the first step is a comprehensive and accurate review of the costs and your finances. The more accurate these figures, the better prepared you will be to find the right mortgage.
Consider the money in your current and savings accounts, and how much you will be able to save in the period leading up to buying a house.
Will you be getting any financial support from parents, family or friends?
The minimum deposit realistically needed for most mortgages is 5% of property value, with better deals available for larger deposit percentages. Taking some example figures, £25,000 could be a 5% deposit on a £500,000 house, or a 20% deposit on a £125,000 house.
Look at whether you are eligible for any government schemes to help house buyers. These provide financial support to reduce the percentage you need to borrow as a mortgage or allow a home to be purchased at a discount.
What are the costs associated with getting a mortgage?
As well as a deposit, you will need to consider the following costs:
- Mortgage account fee
- Arrangement / product / completion fee
- Booking fee
- Estate agent fee
- Legal fees
- Valuation and survey fees
- Telegraphic transfer fee
- Local authority search fee
- Advisor fee
Where to look for a mortgage
Most house buyers get their mortgages from a bank or building society, but they are also offered by:
- Insurance companies
- Mortgage advisors
- House building companies
- Specialist mortgage companies
- Finance houses
Trawling the marketplace by yourself can be very daunting, so many people choose to work with a mortgage advisor. Their expertise and experience is a great way to cut through the noise, and to quickly find deals that are best suited to your specific circumstances. Working with an advisor is covered in our guide mortgage advisors: everything you need to know.
There are many types of mortgage available, each offering benefits and drawbacks. The best type of mortgage for you will be determined by your circumstances, how much deposit you are able to save, whether other people will be able to help you, and various other factors.
The overall amount you will pay back depends on initial amount borrowed, interest rates throughout the duration of the mortgage term, length of mortgage term, and how diligent you are with making repayments.
A mortgage advisor is a trained professional who can help you find the best mortgage for your needs, and whose expertise can reduce the confusion of the selection and application process.
If you have any questions about types of mortgage, or any other aspect of the house-buying process, get in touch with our team of experts, who will be happy to help.