What you need to know about mortgages: part one
Home ownership is in decline, indeed The Guardian reported that home ownership in England was at its lowest level in 30 years; gone are the days of no deposit mortgages and lower prices, but when you have enough money saved, you then face the decision of tracker versus fixed, multiple interest rates and little explanation of how they work for your individual situation.
What are the next steps; which type of mortgage is better than the others? Have no fear, here’s our simplified guide on how they work and where to go for help.
What is a mortgage?
A mortgage is a loan taken out with a building society or bank and used to buy a house or other property. They are typically spread across a period of 25 years and paid in monthly instalments.
The lender has security over the property which means that if you fail to keep up with repayments, they have the right to take over the property and sell it.
You will first receive a 'mortgage in principal' based on your income and savings amount and it can only be used to meet market value of a property. Be careful when bidding over market valuation - your mortgage may go up to £160,000, but if you bid £20,000 over a £140,000 valued house, then it's you who has to stump up that extra £20,000!
How do they work?
Most mortgages are repayment – or capital and interest – and work the same way standard loans do.
The monthly payments include both interest and the capital balance. At first, the capital part might be quite small, with most of the payment made up of interest, but this changes as time passes. This means you are largely paying towards the extra charges for taking out a loan, rather than paying off the home you have bought.
By the end of the 25-year term (or 30 years, depending on what you choose!), the loan will be paid off. Interest-only mortgages used to be the popular option, and the capital sum was paid off from some other form of savings at the end of the term. However, this has become increasingly uncommon.
Savings set up to repay the loan, such as an ISA, can’t be guaranteed to grow sufficiently to repay the loan, therefore there is a risk that at the end of the term, the property may need to be sold.
In some cases, borrowers took out interest-only mortgages without setting up a way of saving to pay off the loan. Instead, they anticipated their property growing in value, however, as property prices have slowed and even dropped, this created issues where homeowners were unable to pay back their loans in full.
It is now much more difficult to get an interest-only mortgage, with many lenders only granting them for those with 50% equity.
How is mortgage interest calculated?
- Fixed rates
A fixed rate mortgage has the interest at the same rate for a set period of time, normally two, three or five years. It affords the borrower peace of mind as the repayment will not change when interest rates do.
This can be slightly bad news, however, if interest rates drop and your payment stays at the same level. Conversely, you are protected when interest rates go high. It all depends on the buoyancy of the wider housing market. There may well be a tie-in or early redemption penalties, which could make this a more expensive form of mortgage.
- Tracker and variable rates
This means that the rate can change based on decisions by your lender or the Bank of England base rate. Tracker mortgages will be linked to the rate of the Bank of England base rate for a certain period.
For example, the product could be set at 2% above the Bank rate and as that is currently 0.5%, the rate paid would be 2.5% as at November 2016. Some trackers offer options such as the ability to cap the amount the rates can rise to or to be able to repay larger amounts to reduce the capital amount.
Historically, these have been a cheaper option than fixed-rate mortgages, with the risk that the rate could rise – that £600 per month charge could become £900! It is good advice, then, to avoid properties that squeeze the margins on your pay packet.
Hypothetically stress-test your wages: it is recommended that you spend no more than 40% of your net monthly income on mortgage repayments and this is where online mortgage calculators come in handy.
When the rates are low and stable, lenders are more interested in promoting fixed rate mortgages.