If you are hoping to buy your first home, or thinking of moving home, one of the most important financial decisions to consider is your mortgage. What kind of mortgage is best for you? Where is the best place to look? And how much will you be able to borrow?
These questions are also important if you are already paying a mortgage which is on a fixed rate, and that rate is due to end in 2024. Around 1.6 million mortgages in the UK are in this position. Interest rates are now much higher than whenever you took out your fixed rate mortgage. For example, if you took out your mortgage in:
The average two-year fixed rate is now around 5.75% and the average five-year fixed rate 5.36%. And variable rate mortgages are higher still, on average 7-8%. So if your fixed rate mortgage is ending soon, you could face a large increase in monthly mortgage repayments.
The good news is that the Bank of England recently announced an interest rate cut from 5.25% to 5%, the first drop in rates since March 2020 as the UK entered the first Covid lockdown. But interest rates are closely linked to inflation, which has risen slightly since the interest rate cut. Which means that it’s hard to predict whether interest rates will be reduced again any time soon.
So if you are looking for your first mortgage, a new mortgage to move home, or a remortgage after your current fixed rate deal, where do you start?
In this article we take a quick look at the main types of mortgage available, and how to get the best deal that you can. We will explore:
Before you consider the best type of mortgage for you, you need to do a bit of preparation. Three key things to look at are:
Any mortgage lender will want to ensure that the mortgage repayments are affordable for you. This can feel like a gruelling process but it’s important that you don’t take on more debt than you can afford as, ultimately, this could lead to you losing your home. So gather as much financial information as you can. For example:
Also check your credit report to make sure that you have a good credit rating and that there are no errors on it that could cause a glitch in the process.
Be aware that the exact amount a mortgage lender will be prepared to lend you depends not only on your financial circumstances but on their own lending guidelines. Most lenders will lend between 4.5 and 5.5 times your annual salary, but this does vary between lenders.
If you are moving home, the equity on your current home will normally be enough to serve as a deposit on your new mortgage. But if you are a first time buyer, you will need to contribute some money up front as a deposit on your home. The mortgage is then added to your deposit to make up the full value of the home.
Under the Mortgage Guarantee Scheme, which will run until June 2025, you can buy a home with 5% deposit, but many lenders prefer a 10% deposit as this reduces the risk for them. It is usually also possible to get better mortgage deals – such as lower interest rates and lower monthly repayments – the higher the deposit you are able to make.
Closely related to the amount of deposit you are able to make is LTV – Loan-To-Value. This is the percentage of mortgage compared to property value.
So if you are buying a property worth £250,000, and have a 10% deposit of £25,000 you will need a mortgage for £225,000 to pay for the rest of the property. Your LTV will be 90%.
Knowing what LTV you need to borrow will help you to filter the mortgage deals that are available to you.
The two main types of mortgage are variable rate and fixed rate.
Payments on a variable rate mortgage will change if interest rates go up or down. Interest rates fall, the amount of interest charged on the mortgage will usually also fall, leading to a reduction in the amount of your monthly payments. But if interest rates rise, interest on your mortgage is also likely to rise, so your mortgage payments will increase.
There are three main variable rate mortgages available:
The specific rate of interest on your mortgage is set by your mortgage lender and payments can be changed by your lender in response to rises and falls in UK interest rates. A typical variable rate mortgage in the UK is currently around 7-8%, though some lenders offer slightly lower rates for first time buyers.
The rate of interest on your mortgage is set by your mortgage lender at a value relative to the Bank of England base rate. So for example, if you have a tracker mortgage of base rate plus 1% you will always pay a rate of interest on your mortgage that is set at 1% higher than the base rate.
The rate of interest on your mortgage is set at a percentage below your lender’s standard variable rate, usually for a fixed period of time, typically a couple of years. So for example, if your lender’s standard variable rate was 7.5% and your mortgage had a 2% discount, you’d pay 5.5%.
With a fixed rate mortgage, your mortgage payments will be fixed at the same interest rate for the duration of the mortgage deal, usually between 2 and 10 years. No matter what happens to interest rates during that time, your mortgage payments will be unaffected.
At the end of the deal period, your mortgage will either move onto your lender’s standard variable rate, you can enter into another fixed rate deal with your current lender, or look for a remortgage elsewhere.
The advantage of a fixed rate is that you know exactly how much you will have to pay despite whatever else is happening in the economy. If interest rates rise, this is a good thing as your existing interest rate is protected. But if interest rates fall, you could be making much higher payments than you would on a variable mortgage. In this case it may be worth looking to remortgage, but bear in mind that there is often a penalty to pay if you leave a fixed rate mortgage deal early.
Most people’s immediate thoughts when looking for a mortgage are to go to their current bank or building society. This can certainly be a good place to start, and you may even be offered a better deal if you are a long standing customer.
But it is always worth looking around to see what else is out there. You can look online at comparison sites such as Money Supermarket, Compare the Market and Uswitch. Uswitch works in partnership with a mortgage broker Mojo, who could also handle the mortgage paperwork for you if you wanted them to do this. Another alternative is to make an appointment with a local financial advisor or mortgage broker to see what kind of deal they may be able to find and arrange for you.
When looking for mortgages, always check if there are any additional fees to take into consideration. These can include:
Some lenders will give you the option of adding the fees to your mortgage loan. Whilst this takes the pressure off you to find even more money up front, just be aware that it will mean you paying interest on these charges for years to come.
But how many years do you have to pay your mortgage for, and is it possible to pay it off early?
Traditionally, mortgages have been over a term of up to 25 years. However, since 2022, half of first-time buyer mortgages have terms longer than 30 years. The advantages of a longer mortgage repayment period is that monthly repayments are smaller than they would be on a shorter term, but the overall amount of interest you have to pay over the lifetime of the mortgage will be higher.
However, it is possible to overpay your mortgage. Making even small overpayments can make a significant difference to the overall cost of your mortgage by reducing the amount of the loan and the associated interest you have to pay. This in turn can reduce the length of time you have to pay your mortgage for.
The one thing you need to check with your lender is the amount of overpayment you are allowed to make under the terms of your specific mortgage deal. If you’re on your lender’s standard variable rate, there may be no limit. But most fixed-rate mortgages – and some tracker mortgages – have an annual overpayment limit of 10% of the total outstanding mortgage balance.
Once you know how much you can overpay, you need to ensure that the overpayment is used by your lender to reduce your overall debt and shorten the term of your mortgage rather than reducing your monthly payments.
You can get an idea of the impact of overpaying your mortgage by using the Money Saving Expert mortgage overpayment calculator here.
If you find yourself in the position at any stage of being able to repay your mortgage in full, you need to check with your lender if there are any ERCs – Early Repayment Charges. ERCs are generally charged on fixed rate mortgages of five years or more, and can initially be as much as 5% of the total amount of your mortgage balance. So check with your mortgage lender and, if an ERC does apply, you need to weigh up whether it is worth paying this to get rid of the mortgage, or continuing to make mortgage – and interest – repayments, adding on the maximum overpayments allowed until it is cleared.
We hope that this article provides helpful information about mortgages, the various factors to consider, and how to go about paying less.
Good luck with your mortgage search. And do check back in with us here again soon for more financial and lifestyle tips from new direct lenders Munzee Loans.
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