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
Head of Mortgages
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Posted 15 FEBRUARY 2020

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% because of the coronavirus pandemic. 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. This can be done by building your credit score, which the mortgage provider will check before deciding whether or not to lend you money. The more reliable a track record you have of paying back debt, the more you’ll look like a responsible borrower and be able to benefit lower interest rates.

A large deposit also makes you less risky to lenders, so the more 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.

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. This is 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 deal 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 things, 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 something changed – if you lost your job, for example, or 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.

Usually an Agreement in Principle is made with 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 – so 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 include:

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

Find out more about mortgage costs and fees.

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 seek 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 what’s known as whole-of-market brokers, so they can look at the entire mortgage market and recommend the right deal for you. Some mortgage brokers may charge you a fee for finding a mortgage for you – so make sure you fully understand any charges when working with a broker.

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) are 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 are 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.

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