Introduction
There are a lot of different types of mortgages that range from standard residential mortgages to a buy to let mortgages and even mortgages like those for first-time buyers. In this article, all of them will be talked about in detail so you know which one is best for your specific property purchase as well as the pros and cons of each one.
The topic of mortgages is far more complicated than just seeing a mortgage as a loan taken out by a lender that you pay back. So read on to stay up-to-date and informed on the topic.
What exactly is a house mortgage?
First of all, when speaking about the broad term of mortgages it is vital you understand what they really are so each type of mortgage makes more sense. Mortgages are a type of loan taken out from a bank or a mortgage lender. Typically, there are two parts to this mortgage, the deposit and the value you have to pay back.
This value you have to pay back typically is paid back while accruing interest. Lenders use mortgages because they can make money by allowing people to borrow. Homebuyers take on mortgages because it allows them to control an asset like a house without having to pay for the whole thing all at once in cash, increasing their buying power.
Over time, someone who has taken on a house mortgage will be able to own the house if they continue to make their mortgage payment. However, over the years they would have paid for more than the initial value of the house because of interest on the mortgage.
Nonetheless, without the interest on a mortgage, lenders would not lend the money in the first place because they would make no money from allowing people to borrow money.
What is the current rate of interest on house mortgages?
As of 2022, because of current affairs like the recent pandemic and wars between Russia and Ukraine, inflation in the UK has climbed as high as 9% in some reports. For more on this click here.
As a result, central banks and local banks have increased their interest rates in order to combat inflation. The way this works is interest rates get increased which restricts the number of people taking on credit, as a result, borrowing becomes expensive so there is less money circulating and changing hands in the marketplace in general.
Because most people not being able to buy, there is a decrease in demand and the price of goods and services and in this case property, decreases. This decrease in property prices helps combat the inflation rate.
For example, if the inflation rate went up by 9% and so interest rates went up and the price of homes went down by 9%. The overall change in the value of a home is zero.
As a result, a higher interest rate of 9% in the UK economy has led to interest rates having to be spiked up as high as 6.53% on average for two-year fixed rate deals in the UK as of October 2022. This is a massive increase from not too long ago when interest rates were 2.44% at the same time in 2020. The BBC talks about how interest rates have changed in this way here.
How do house mortgages work for buyers?
In simple terms, mortgages work because it solves the problem of most people not having enough cash to buy a home straight away like in an auction. Instead, they just need a deposit and to pay back a mortgage to a bank or lender over time preventing them from having to use other methods of house purchase like buying a house with no money.
They benefit the homebuyer because they can eventually own an asset and they benefit the bank because they’re able to charge interest on money without having to do much but make sure the property is a good investment and they can make their money back and lend the money to whoever needs it. This money is paid back in something called repayments.
How do house mortgage repayments work
The term ‘repayments’ when referring to mortgages refers to the method in which a mortgage lender expects a home buyer to pay back their loan. There are a few different methods in which a lender can set this out because there are a few ways that banks and lenders make money on mortgages. But ultimately they are all just different ways of charging interest on money borrowed.
Interest-only mortgage repayments
Interest-only mortgage repayments are common in buy-to-let mortgages. For example, a buyer will find a house they want to buy, put a deposit on the house which can be anywhere from 15% – 40%, and then pay back the interest on the rest of the loan.
A real-life example could be putting £30,000 down as a deposit on a £100,000 house. This means the buyer would have borrowed £70,000. The buyer would then pay back the interest on the £70,000 not the actual value of the loan. This interest could be 4% for example, in which case the interest paid back over the terms of the mortgages (usually 2 to 5 years) would be £2,800.
The rest of the loan of £70,000 can be paid back at a later date after the term of the mortgage. This is done by remortgaging a property or buying the property outright in cash. But most investors would choose to remortgage.
Combined mortgage repayments
Contrary to interest-only mortgage repayment, a buyer can also choose to take on a loan where they back the equity of the loan as well as the interest payments. This is common whenever buying a normal home but you can also do this in a buy-to-let mortgage too.
Using an example, if there was a £30,000 deposit put down on a £100,000 house and the loan had a 4% interest on it, there would be £70,000 left to pay back. If you combined this rate but the mortgage was stretched out over 20 years, there would just be a figure of roughly £300 to pay back every month for 20 years in order to pay back the mortgage.
The difference is, because the term of a mortgage like this is likely to be far longer, the mortgage payments aren’t too dissimilar in value compared to an interest-only mortgage which would typically have a fixed rate of two to five years.
What kind of house can I afford to buy using a mortgage?
As a general rule, mortgages for first-time buyers buying a new build can be as little as 5%, for residential mortgages slightly higher at 15% – 30% and for buy-to-let mortgages as high as 40% in some cases depending on the length of time of the deal and the deposit paid. So, if you can afford the deposit in cash, relative to the value of the house, most of the time you would be able to afford to buy.
Having said this, there are other factors which impact your ability as a landlord to pay back the loan over time. Banks do not like lending money if the investment for them is considered risky. This is why they look at other factors such as your personal income, personal documents and your credit score. However, please read some tips on obtaining a mortgage without payslips if you know you have a bad credit score.
A mortgage in principle is an indication that a lender could lend a specified amount, based on the details the applicant has provided about annual income, personal spending and outstanding debts. It is given by comparing the valuation of the property from a house survey to the level of debt that a buyer can take on based on their income.
In other words, the better you are able to demonstrate that you can pay back the mortgage effectively, smoothly and without any defaults, the better.
So even if you think by using a deposit you can afford a house you’re looking for, there may be another factor such as credit score that impacts your ability to gain approval for a mortgage anyway.
This is why it is common for first-time buyers to find it harder to gain approval for mortgages whereas those who have bought second homes or completed complex deals like a build-to-rent deal have a wider range of mortgage offers available to them.
First time buyers struggling to get on to the housing ladder should therefore see how their pensions compare to property investment as a last case resort. Reading our article on alternative property investments may also give you some bright ideas.
Does my salary impact how much I can borrow?
If you are applying for a residential mortgage (A mortgage for a house you intend to live in), a lender will definitely look at your personal income to determine if you are able to pay off the mortgage for a house. Not only will they look at your current income but they will also look at your income history and the reliability of the profession you are in.
If you are buying another mortgage such as a buy-to-let mortgage (a mortgage for a home you plan to rent out without living in). This type of mortgage is approved and negotiated based on the property’s ability to generate rental income rather than your personal income by itself.
However, a lender may also look at a landlord’s personal income as a secondary factor in the approval of a buy-to-let mortgage in this case. It just won’t be considered as important.
What mortgage do I need to buy my house?
There are a few terms to be familiar with to truly understand what type of mortgage you should be taking out as a homeowner. From ‘buy-to-let’ mortgages to other terms like “home remortgages”, it is important to understand the mortgage type and the terms surrounding them.
There are similarities and differences across the board and this will impact what type of lender to look for as some banks and lenders specialise in different areas. It could be the case for example that going to the same bank for a buy-to-let mortgage and a residential mortgage would give you different results and different deals.
It is important to shop around and get offers from a range of lenders because they all have different criteria for approving a mortgage to begin with as well as different lengths of deals and interest rates they like to offer.
A re-mortgage
A remortgage is where a property has a mortgage on it and you apply for another mortgage with a different lender to pay off the first mortgage and adopt different terms. This can also be done within the same lender or bank. However, in this case, it is usually called a ‘product transfer’ rather than a remortgage as a landlord would be sticking with the same lender but negotiating different terms.
Why should you remortgage a property?
Remortgaging is often done to save money as the homeowner knows they can get a cheaper deal on a mortgage which will reduce their interest rate by cancelling one deal and moving on to the next. This can also be done without cancellation fees by waiting for a mortgage term to end. This is common in buy-to-let mortgages after the first initial fixed-rate period.
Other than this, a remortgage can be a great way to pull equity out of a house. For example, if you know a property has appreciated in value or the rental income has increased, this means the property’s overall value has gone up. Therefore, if you get a property valuation, the new value of the house would be greater than the initial value that the first mortgage was based on.
In this case, you could pull money out of the deal and perhaps use this cash to put a deposit on a new house or keep it as personal income, a common method used to buy a property with no money. However, this may not always work out as things like mortgage cancellation fees and solicitor fees could make the overall gain not worth it.
There are also circumstances where you should remortgage a property if you are facing a divorce in which case you will also need a mortgage capacity report.
How to work out how much a re-mortgage will cost
Working out how much you could save on a remortgage depends on three main factors. These include:
- The number of years you have left currently on a mortgage
- The amount of money left to pay off the current mortgage
- What the current monthly payment is for your current mortgage
Once you know the value of all three pieces of information. It would be as simple as going to a lender, asking to borrow the amount left over on the mortgage based on your preferences for a new mortgage and the lender will take it from there giving you a series of options.
Based on the current economic climate, the amount of money you have left to pay back alongside the reason for your remortgaging in the first place will also be deciding factors in what, if any mortgages are available to pay off your current loan and move forward.
When is the best time to remortgage a property?
When remortgaging a property, there is a clear need to do it at the right time. Perhaps the biggest factor in whether a remortgage makes sense is looking at the current typical interest rates lenders and banks are offering.
Other than this, the rest is up to you and your preferences, if you get a new valuation for a property which provides evidence a remortgage would suit you, that would be a good time to remortgage a house. Other than this, coming to the end of a term in a mortgage would also provide you with a good reason to change lenders while you can.
Mortgages for first-time buyers
As a first-time buyer, there are a few incentives given by the government in order to aid your introduction to the housing ladder. One of the most well-known incentives is the help to buy scheme which is available for first-time buyers who are interested in taking out a mortgage for a new build property.
The help-to-buy scheme is often referred to as a first-time buyer mortgage or a 95 mortgage.
Who qualifies for a first-time buyer mortgage and why?
If you are a buyer who has never been a landlord anywhere in the world before and only ever rented then you are eligible for the first-time buyer scheme. However, it is vital you also only buy a new build property as this is the category of property the scheme applies to.
In addition to this, you have to be buying a property to live in yourself rather than let out if you want to still be classed as a first-time buyer. Having said this, you can still have lodgers in your property or remortgage the house later down the line into a buy-to-let mortgage for example allowing you to let tenants in the house legally.
What is the size of the deposit you need as a first-time buyer?
First-time buyers buying a new build property only need a 5% deposit using the help-to-buy scheme. This is because 5% of the value of the house will qualify them for a government loan or equity loan.
This loan can be 20% of the value of the house or 40% in London. This equity loan is then used as the deposit for the mortgage. Nonetheless, it is important not to stretch yourself too thin as a first-time buyer because there are other costs like home insurance and potentially stamp duty or land and building transaction tax on top of a mortgage that will also cost you money.
What are buy-to-let mortgages?
Buy-to-let mortgages are mortgages taken out typically by investors who wish to buy a property and let it out to renters. These investors make money by keeping the profit in between the mortgage costs and other expenses of the property and the rental income rather than paying off a mortgage based on personal income and waiting for the property to appreciate to make money like most homebuyers.
However, this profit has been reduced over the years because of the introduction of section 24 where landlords can no longer deduct mortgage payments from their tax bill directly and have to instead pay tax on the gross rental income rather than the net profit of a property.
Usually, the rental yield of a buy-to-let has to be 125% – 135% above the mortgage payment interest in order for the mortgage application to be approved.
What is a home mover mortgage?
A home mover mortgage is the same as a standard residential mortgage. This is so you find the most suitable mortgage for your new home if you do not have the option to transfer the mortgage from one home to the next which is known as a ‘portable mortgage’.
Typically, home mover mortgages are used when someone upgrades their home in size and wants to take on more debt in their mortgage overall.
Do you need to put down a deposit when moving house?
When you move house, you may wonder how you’re able to pay a deposit on a house you’re moving into if the original house hasn’t sold yet.
Most of the time, especially if the equity from the value of the new house you’re buying is less than the original house, the equity of the old home you’re selling will be used as a deposit. This is known as a buyer chain where the bottom of the chain is used to finance a property at the top.
In summary
When looking at house mortgages overall, there are a few main types of mortgages you have to know the differences between such as interest-only mortgages and combined mortgages. However, once you understand the main points, the real difficulty is knowing how to gain approval for the mortgage you want and knowing when the best time to take out a mortgage is.
House mortgages are the best way to control an asset like a property without having to have all the funds in place when buying a property outright which gives a buyer leverage in the property market. So understanding these technicalities will only serve you well in the long term if you are interested in buying a house. Whether that be to live in or for an investment.
Interested to know how to use an SA302 form to verify your income? Check our dedicated article.
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