How do mortgages work?
How do mortgages work? And what are the different types of mortgage out there? We’ve got all the key facts here.
Last updated on
Oct 15, 2024 12:15
A mortgage is a loan that you can get to help you buy a property. Because, let’s face it, not many of us have a spare few hundred thousand pounds tucked away down the back of the sofa to help us buy a place outright.
Here’s how they work – what deposit you need, how to actually get a mortgage, and the different types of mortgages out there.
A mortgage loan can cover most of the money you need to buy your dream home, as long as you can provide a deposit (an amount of cash upfront).
The deposit will usually need to be at least 5% of the value of the property you want to buy (although most lenders ask for 10% or more). For example, to get a mortgage on a £300,000 house you might need a 5% deposit of £15,000, or a 10% deposit of £30,000.
The mortgage loan then covers the rest of the property value. So if your deposit is 5%, a mortgage would cover 95% of the property value. If your deposit is 10%, a mortgage would cover 90% of the property value. You get the picture.
In our example with a £300,000 house, you’d need a mortgage of £285,000 if your deposit was 5%, and a mortgage of £270,000 if you put down 10%.
The size of deposit you can put in compared to the size of the mortgage is known as the loan to value ratio (or LTV). LTV is one way that lenders work out how risky it is to lend to you. To a lender, a low LTV (bigger deposit, smaller loan) means a lower risk customer.
That’s why you’ll often see lenders offer lower mortgage interest rates to customers with bigger deposits – because they see those customers as less of a lending risk. (Interest is essentially the fee that you pay to “hire” the lender’s money. It’s charged as a percentage of what you owe in total.)
If you’ve put in a bigger deposit (meaning a lower risk to the lender), your mortgage interest rate will typically be lower. If you’ve put in a smaller deposit (meaning a higher risk to the lender), your interest will be higher.
You can find a mortgage deal by:
Let’s take a look at the different types of mortgage available in the UK.
The vast majority of mortgages available on the market are repayment mortgages. This means that each month you’ll pay back a chunk of your mortgage loan, plus any interest (the fee your lender is charging you to “hire” their money).
With a repayment mortgage, you’re aiming to pay off the full amount you borrowed by the end of the mortgage term (usually 25 years or so).
If you have an interest only mortgage, your monthly payments will only cover the interest on your loan. You’ll still need to pay off the full amount you borrowed at the end of the mortgage term.
Why go for an interest only mortgage? Well, you might decide that you’d rather pay off your loan all at once, using something like your savings or shares. Also, most buy-to-let mortgages are interest only (that’s the type of mortgage you get for a property you’re letting out, rather than living in).
A fixed rate mortgage deal means that your monthly payments stay the same for a fixed period of time. This is usually between 1 and 5 years (although with the Habito One mortgage, you can actually fix the price of your payments for the whole mortgage term).
You might choose a fixed rate mortgage if you want a bit more certainty in your finances. It’s easier to budget if you know exactly what you’ll be paying for the next few years.
Once your fixed rate mortgage deal has ended, your lender will usually transfer you automatically to a variable rate mortgage. This means that your monthly interest payments aren’t guaranteed to stay the same any more: they will change according to your lender’s standard variable rate (SVR).
Your lender sets their standard variable rate by looking at the Bank of England’s base rate (that’s the interest rate your lender is paying to borrow money from the Bank of England) and other factors, like the level of risk involved.
So, with a variable rate mortgage, your interest payments can go up and down – which means you may end up paying less (awesome) or you may end up paying more (not quite so awesome).
If you want to get off your lender’s standard variable rate, which most people do, you can remortgage to get a new fixed rate mortgage deal. Or you could go for a special kind of variable rate mortgage deal:
Like fixed rate mortgage deals, these variable rate deals will last for a set number of years before your lender puts you back on the standard variable rate.
That’s right, there’s more. There are mortgages out there for specific financial or life situations, like if you’re a first-time buyer or you want to get a mortgage with a friend. Here are a few.
Looking at all the different types of mortgages available can feel a bit overwhelming. If you’re not sure which mortgage is right for you, Habito can help.
We’ll set you up with your own personal mortgage expert, who’ll guide you through the process of finding and applying for your perfect mortgage. It’s simple, clear, and free.
Say goodbye to mortgage confusion here.
Here's everything you need to know to improve your credit score.
Habito specialises in helping you get the best mortgage or remortgage, all online, for free