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All about UK residential mortgages for homeowners

by | Jan 29, 2023

Home $ How to buy a property $ A Guide On House Mortgages $ All about UK residential mortgages for homeowners

One of the first steps in that journey is securing a house mortgage, but with so many options out there, how do you know which one is right for you? 

In this article, we will be going over what sets a residential mortgage apart, and how much of a deposit do you actually need to make the right property purchase. With so many lenders and interest rates to choose from, it can be hard to know where to start.

So, whether you’re actively looking for your first home or you just seek the knowledge, read on to discover all you need to know about residential mortgages!

residential mortgages on properties

How is a residential mortgage different from other types of mortgages?

Residential mortgages are different to other mortgages because they are strictly used for buying property where buyers intend to live in the property and pay off the mortgage based on their earned income.

Even the mortgage referencing process is based on the earned income of the person who is applying for the mortgage and lenders consider this as the sole factor in whether the mortgage can be paid back.

In the UK, residential mortgages are the most common type of mortgage as it is what people use to gain access to the housing ladder most of the time by trying to buy a home that they can live in for the long term.

Renting out a property on a residential mortgage

As you may be aware, renting out a property that is on a residential mortgage is against the terms of the agreement a buyer has in place with a lender. As a result, creative solutions are required to get around this.

If you are found to be in breach of the terms of a mortgage in this way, a lender has the right to repossess the property in a lot of the cases and they may demand that the buyer pays back of the mortgage quickly

For instance, if there is 50% of the value left in the mortgage, a ledner may demand they pay 25% of the mortgage within a month or the property will have to be repossessed. This will of course come with the buyer having to get rid of the tenants.

However, there are legal ways to rent out a property- that is on a residential mortgage. This is by having one or two lodgers in a property that help to increase a buyer’s income as they live in the building.

There are also government incentives for this such as the rent a room scheme which allows buyers to take home up to £7,500 completely rent free every tax year.

However, if you are trying to sign a tenant using an assured shorthold tenancy rather than a lodger agreement, this is illegal and a mortgage lender can take legal action if a buyer is found to be doing so.

The only other way to get around this and rent out a property legally is to remortgage a property onto a buy to let mortgage but this will require the landlord to move out of the property and additional knowledge around tax laws such as section 24.

As a result, a lot of buyers looking to rent out a property end up doing let to buy. This is where they manage to pull out some or all equity from their residential home and use this new equity for a new deposit.

residential property bought using mortgage

How to remortgage a residential mortgage

In order to remortgage a residential mortgage, the first thing you should do as a buyer is make sure that you’re in positive capital appreciation in the property so you don’t have to pay money to the bank to remortgage and ideally the property should be unencumbered.

This is done by having capital appreciation in a property. For instance, if a property was bought for £200,000 five years ago and it is now worth £250,000, the buyer is able to remortgage and pull out £50,000 of equity with the new mortgage value.

However, if there has been capital depreciation in the property in the previous five years and it is now worth £150,000, the homeowner may have to pay the bank the extra £50,000 to remortgage a property.

If this is the case, the buyer should question whether it is worth remortgaging at all. Unless there is an emergency and the buyer needs to be out of the deal as soon as possible this wouldn’t make much sense.

Whether a remortgage makes sense at the time all depends on the price that the buyer originally bought the property for and what the economy is doing at the moment.

How much deposit is required for a residential mortgage?

When a buyer goes to the bank and asks for a mortgage, they first have to conduct an initial mortgage in principle that they can bring to house viewing to prove they are eligible for a certain amount of money from the bank.

Sometimes, this isn’t necessary if the buyer is particularly confident, perhaps because they have had a mortgage capacity report in the past, but through this process, the amount of deposit that is required should be revealed.

Typically, for a residential mortgage, this figure lies somewhere around 20% and the buyer also has to prove the mortgage value is worth 4 to 5.5 times their annual income. Any more and a lender is unlikely to approve the application.

In cases where a buyer doesn’t meet an affordability check, they may have to add a mortgage guarantor to the deal so the mortgage application can move forward and gain approval from the lender.

In cases where a buyer earns a lot of money, they may want to look at specialised ledner who focus on high net worth mortgages. Typically, better interest rates and deals are able to be found in this way.

An example of a residential mortgage in the real world

To make an example in the real world, if you were looking to buy a home worth £200,000 and you have a deposit of £20,000. With a typical residential mortgage, you’ll borrow the remaining amount needed to purchase the home.

This remaining amount would be £180,000 which means the loan to value ratio of this mortgage would be 80%.

Next it is useful to calculate the interest rate on the mortgage to determine the amount you’ll need to repay each month. If the interest rate is 3%, your monthly mortgage repayments will be approximately £620.

This amount includes both the interest and the repayment of the principal amount borrowed. This is different to an interest only mortgage where the interest payment is the only payment necessary.

In addition to the mortgage repayments, you’ll also need to factor in additional costs like home insurance, property taxes, and maintenance expenses so the costs won’t be this simple if you were to buy a property in real life. 

Let’s say home insurance costs £200 per year and additional costs to maintain the property is £1,000 per year, the total cost of homeownership would be £620 (mortgage repayments) + £200 (home insurance) + £1,000 (maintenance) = £1,820 per year.

It’s important to note that unless you’re able to get a fixed term mortgage, the interest rate can change over time, so it’s important to carefully consider your budget and financial stability when deciding on a residential mortgage.

calculate residential mortgages

By checking out all of the terms and conditions of the mortgage in detail, you can be sure you’re making the correct decision to buy the property you’re after and be in with the best chance to buy a property that is an investment that makes sense.

If some of these numbers don’t make sense, you can check out your own affordability by using online calculators such as this one here. Being able to change the length of the mortgage term will greatly impact how affordable the mortgage is.

How much can you borrow using a residential mortgage?

The typical industry rate that lenders use to see how much an individual or a household can borrow is by looking at 4.5 to 5.5 times the annual salary of the mortgage applicant’s household.

For instance, if a woman wanted to buy their house with their husband and they are both on a salary of £50,000, their annual salary would be a combined £10,000 making them eligible for a mortgage that is worth £450,000 – £550,000.

If you’re self-employed, you’ll have to fill out a self assessment form sa302 in order to prove to a lender that you are earning enough and perhaps issue a few years of evidence as well.

This self employed salary would have to be at least the same as someone who is working a conventional job.

How to find the most affordable residential mortgage

The biggest tip to find the most affordable types of mortgage is to wait for the right time in the economy when interest rates are low and also shop around. Don’t just take the first mortgage offer you’re given.

There are also schemes such as the help to buy scheme that help members of the public purchase new build properties for just 5% down, known as a 95% mortgage. Find out more here.

What are the interest rates for residential mortgages?

The type of interest on your mortgage can also be influenced by the credit score you have. If your credit score is particularly bad, you may wish to find ways to take out a mortgage without payslips to gain approval.

However, depending on the state of the economy, a typical interest rate on a mortgage should be between 1% – 5%. The higher the interest rate, the less mortgage applications are approved due to affordability dropping amongst buyers.

Table on interest rates in the UK from 2010

This table demonstrates the fall in interest rates over a decade since the end of the last recession in 2008.

mortgage interest rates trends

Types of residential mortgage

Before you go ahead with purchasing a house to live in with a residential mortgage, you should be familiar with some mortgage terms that will help you make the right buyer decision.

Tracker

A tracker mortgage is one where the interest rate changes based on the Bank of England base rate. This means a mortgage payment can change quite a bit from month to month.

Typically, whenever a buy to let mortgage comes to the end of its fixed term interest rate, the mortgage then becomes a tracker mortgage. However, residential mortgages can be tracker too. For more on what a tracker mortgage is click here

Discounted

A discounted mortgage is similar to a tracker mortgage because the interest rate changes. However, instead of being above the Bank of England base rate, the interest rate is set below a lender’s standard variable rate.

This standard variable rate (svr) is what other mortgages could be set at which means it is highly likely the buyer is getting a good deal below market rates.

Current account mortgage

A current account mortgage allows you to use the account where you save money or get paid into known as a current account to act as a deposit for a mortgage.

As a result, as the current account receives money, the deposit increases, the loan to value ratio of the mortgage decreases and the buyer then [ays less interest on their mortgage.

Wrapping things up

In conclusion, a residential mortgage is a crucial component of home ownership, and it’s important to understand the ins and outs of this type of loan to make the right decision in a home purchase. 

Whether you’re a first-time home buyer or looking to remortgage, it’s important to consider factors like deposit requirements and interest rates when choosing a residential mortgage. 

By taking the time to research and compare options, you can find the best deal and set yourself up for a successful home ownership journey. 

Remember that if any of the terms of a mortgage don’t make sense or you simply want to increase your chances of getting a good deal. You can always use a mortgage broker.

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donnell-bailey

Donnell Bailey

Property expert

Donnell is a property expert focusing on the property market, he looks at a combination of legislation, information from property managers, letting agents and market trends to produce information to help landlords.

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