What is a mortgage?

Many people dream of having a home to call their own, but the first step on the road to property ownership is applying for a mortgage. We explain the basics to help you understand how mortgages work and the different types available.

Many people dream of having a home to call their own, but the first step on the road to property ownership is applying for a mortgage. We explain the basics to help you understand how mortgages work and the different types available.

Daniel Evans
Mortgages expert
10
minute read
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Posted 15 FEBRUARY 2020 Last Updated 9 JUNE 2022

What is a mortgage?

A mortgage is a type of loan you use to buy a property. As most people can’t afford to buy a home outright, a mortgage is a way to get your own home without having to pay upfront.

To get a mortgage, you’ll be expected to put down a deposit, usually at least 10% of the property’s value – although some providers are now asking for at least 15%. A bank or building society could lend you the rest of the money you need – as long as you meet their mortgage lending criteria.

How does a mortgage work?

When you get a mortgage, you’ll have to pay back the loan – plus interest – in monthly instalments. This is done over a set number of years, typically 25 – but could be longer or shorter. You won’t fully own the home until the whole mortgage debt is paid off.

The interest rate you’ll pay, also known as the mortgage rate, is determined by a range of things, including:

  • The Bank of England base rate
  • The length of mortgage, known as the ‘term’
  • The deposit amount
  • The level of risk to the lender
  • Whether it’s a variable or fixed-rate deal.

While you can’t control the rate of interest you’re offered, you can affect how the lender sees you as a borrower by building your credit score, which the mortgage provider will check before deciding whether or not to lend you money. If you have a reliable track record of paying back debt, you’ve proven yourself to be a responsible borrower and may be able to benefit from lower interest rates.

A large deposit also makes you less risky to lenders, so the more deposit you can save, the better the interest rate you’re likely to get.

Your home may be repossessed if you do not keep up repayments on your mortgage.

Did you know?
If you’re under the age of 40, a Lifetime ISA (LISA) could be a quicker way of saving for a deposit. For every year you save money into a LISA, the government will add a 25% bonus to your savings, up to a maximum of £1,000 per year.

What types of mortgage are there?

There are two main types of mortgage – fixed rate and variable rate.

  • Fixed-rate mortgages have an interest rate that stays the same throughout the length of your introductory deal – typically between two and five years. After this, you’ll automatically move on to the lender’s standard variable rate, which is likely to be higher, unless you switch to a new deal.

    A fixed-rate mortgage can help you budget as you’ll know what your repayments will be each month. But as the rate is fixed, you won’t benefit if interest rates fall.
  • Variable-rate mortgages have an interest rate that can change at any time, which means your monthly mortgage payments can go up or down. There are different types of variable-rate deals available, including tracker mortgages, where the interest rate is tied to the Bank of England base rate, and discount mortgages, where the interest rate is set at a percentage below the lender’s standard variable rate.

    With a variable-rate mortgage, you might benefit from low monthly repayments if interest rates are low, but your repayments may rise steeply if interest rates go up.

What’s the difference between a repayment mortgage and an interest-only mortgage?

Both fixed-rate and variable-rate mortgages are available on a repayment or interest-only basis. These work in different ways.

  • Repayment mortgages: with this type of mortgage, you pay back a fraction of both the loan and interest each month until you’ve cleared the balance at the end of the mortgage term. This is the most common type of residential mortgage.
  • Interest-only mortgages: with an interest-only mortgage, you only pay the interest charged on your mortgage each month. So, when the mortgage term ends, you’ll still have to pay back the amount you originally borrowed (the capital). You’ll have to have a plan in place to do so in order to get an interest-only mortgage – for example, an investment like an ISA. Interest-only mortgages are not as common as repayment mortgages.

An interest-only mortgage may seem more affordable as it will have lower monthly costs than a repayment mortgage. But you’ll need to provide evidence to the lender of how you’ll pay off the capital balance at the end of the mortgage term.

‘Part and part’ mortgages, where the loan is split between a repayment and interest-only mortgage, are also available.

Will I be able to get a mortgage?

Lenders will want to know whether you can afford to pay a mortgage before they agree to lend to you. To assess this, they’ll look at a variety of factors, including how much you want to borrow and what deposit you have.

They’ll also look at:

  • Your income
  • Your employment status
  • Your expenditure
  • Your credit rating

To be as sure as they can that you can pay your mortgage, they’ll ‘stress test’ your finances to see if you could continue to pay if interest rates went up.

The type of property you’re buying – for example, a flat, house or new-build – will also be considered as some lenders may have their own rules about types of property they’re more or less willing to lend on.

Find out more about what makes you eligible for a mortgage.

Get a rough idea of how much you could borrow with our mortgage calculator.

What is a mortgage agreement in principle?

There are two stages of applying for a mortgage. The first is getting an agreement in principle (AIP). This is a written statement from a lender saying they’re willing to lend you a certain amount of money, subject to full affordability checks. To get one, you’ll need to provide information about your finances, including your income and outgoings.

An agreement in principle is usually a soft credit check that won’t affect your credit score, unlike a full mortgage application. But you should check the situation with any potential lender to be certain.

It’s a good idea to have an AIP in place before you start house-hunting as it will give you an indication of how much you could borrow and the type of property you could afford to buy. Also, some estate agents and sellers will only take you seriously if you have an AIP.

While an AIP is by no means a guarantee that you’ll be approved for a mortgage, it’s a good place to start. It’s also not a commitment to a particular type of deal or mortgage provider. You can change your mind and opt for a different deal or different lender when you make a full mortgage application.

Once you’ve found a property within your budget, you can go back to the lender, or another lender of your choice, to make a formal mortgage application, which will include a full credit check.

See how to apply for a mortgage.

What is a mortgage offer and how does it work?

After you’ve found a property, you can apply in full for a mortgage. You’ll get a mortgage offer as a formal response from the lender, setting out the terms and conditions of the offer. How much they’ll lend on a particular property will depend on a valuation of that property.

Most mortgage offers last around three to six months, to give you time to go through the legal process and complete buying your new home. If you don’t manage to buy the property during that time, you might need to ask for an extension. Some lenders may want to recheck your situation to see that what they’re offering is still affordable.

If you’re opting for new-build, you may be able to get a longer mortgage offer. If this is the kind of home you want to buy, it’s worth asking when you apply for a mortgage.

What else do I need to think about?

Be aware that mortgages come with fees and charges that you’ll need to factor into your budget. These may include:

  • a valuation fee to cover the cost of valuing the property you want to buy
  • a booking fee, which is sometimes charged to secure a mortgage
  • an arrangement fee for setting up the mortgage.

Find out more about mortgage costs and fees.

How can I improve my chances of getting a mortgage? 

While each lender has its own criteria, all will want proof that you can be a reliable borrower and can afford your repayments.

Here’s a few ways to help improve your chances of getting a mortgage approval: 

  • Check your credit report before you apply – a mortgage lender will look at your credit history when reviewing your application to see how you manage your debts and repayments. If your credit score isn’t up to scratch, take a few months to improve it before applying for a mortgage.
  • Get on the electoral roll – lenders use the information on the electoral roll to confirm your identity. If you’re not registered to vote, it’s very unlikely you’ll be accepted for a mortgage.
  • Pay your bills on time – missed or late payments will harm your credit score and lessen your chances of being accepted for a mortgage.
  • Be careful about applying for credit – recent applications for credit cards or loans will show up on your credit file. If you make multiple applications and they’re rejected, it could indicate to a lender that you’re desperate for money and your mortgage application may be declined.
  • Repay any unsecured debts before you apply – paying off any outstanding balances on your credit cards and overdraft will not only help boost your credit score, but will also reduce your monthly outgoings, helping you to meet the affordability requirements of mortgage lenders.
  • Consider ‘Help to Buy’ – if you’re a first time buyer, the Help to Buy Scheme could be an easier way of getting on the property ladder with just a 5% deposit.

Where can I get a mortgage?

Mortgages are offered by financial institutions, like banks and building societies. You can apply for a mortgage directly with the lender, compare deals through our comparison site or get advice from an independent mortgage broker.

A mortgage broker is a professional financial advisor who can find and apply for a mortgage deal on your behalf. Some are whole-of-market brokers, which means they look at the entire mortgage market and recommend the right deal for you. Be aware that some brokers can charge a fee for finding a mortgage, so check before you agree to use them.

Compare the Market has partnered with London & Country Mortgages Ltd (L&C)**, an award-winning broker, to provide you with fee-free mortgage advice.

Go to L&C mortgages

**London & Country Mortgages Ltd (L&C) is a multi-award winning mortgage broker with over 20 years’ experience in helping people secure their perfect mortgage. Advice is provided by L&C, who are authorised and regulated by the Financial Conduct Authority (143002).

L&C is not part of Compare the Market Limited. Compare the Market receive a % of the commission that our partner London & Country earns. All applications are subject to lending and eligibility criteria.

L&C will not charge you a broker fee should you decide to proceed with a mortgage.

All applications are subject to status and lending criteria and are based on your individual circumstances. Applicants must be 18+ and a UK resident.

Frequently asked questions

What’s the difference between a loan and a mortgage?

A loan is essentially any financial transaction where you borrow a sum of money and agree to pay it back.

An ‘unsecured loan’, like a personal loan, allows you to borrow money  – usually up to £25,000 – without having to use a valuable asset like your home or car as collateral.

A ‘secured loan’, like a homeowner loan, allows you to borrow a larger sum of money, but you’ll need to use your home as security. This means your home could be repossessed if you can’t keep up with the repayments.

While you can take out a loan for various purposes, a mortgage is a type of ‘secured loan’ that’s used to buy a property. If you fail to keep up with your mortgage repayments, you could risk losing your home.

What is a mortgage LTV?

The LTV, or loan-to-value of a mortgage, is the ratio between the size of the mortgage you take out and the value of the property. LTV is always shown as a percentage.

If you want to buy a house worth £250,000 and you have a deposit of £50,000, you’ll need to borrow £200,000. Your deposit is 20%, so your LTV will be 80%. This means that you need to look for a mortgage deal with an 80% LTV.

Typically, the best interest rates are offered to those with a lower LTV.

What is a remortgage?

A remortgage is when you switch to another mortgage deal, using the same property as security. You can remortgage with the same lender or a different provider.

Most people remortgage when they come to the end of their fixed-rate deal. This could be to get a better interest rate, cheaper monthly repayments or to free up cash by releasing the equity in their home.

What is porting a mortgage?

Porting a mortgage is when you move home and take your existing mortgage with you. Not all lenders let you port your mortgage, so if you want the option, check before committing to a mortgage dea.

Find out more about porting a mortgage.

What is a guarantor mortgage?

A guarantor mortgage is where a family member or close friend guarantees to cover your mortgage repayments if you can’t.

A guarantor mortgage is an option if you’re a first time buyer or you have a poor credit history. As your guarantor is offering security for the loan, there’s less risk for the lender and more chance of you being approved for a mortgage.

However, this type of mortgage is a huge financial commitment for your guarantor. They must be a homeowner themselves – and if your mortgage payments can’t be met be either of you, you both risk losing your homes.

Find out more about guarantor mortgages and how they work.

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