Financing Your Home: An Introductory Mortgage Guidefjpinvestment
So, you are thinking of purchasing your first home or buy-to-let property investment, or maybe you are looking to expand your portfolio and would like to take a refresher on mortgages. Mortgages can be perplexing, even for those who have previously purchased a home. Here we have prepared a condensed mortgage guide to help you navigate the right mortgage choice for you.
Let’s start with the most obvious question: what is a mortgage?
A mortgage is the name given to loans for the purpose of purchasing property and land. Some can finance their property purchase with cash savings, while the majority must rely on a loan from mortgage lenders. Mortgages typically have a 25-year term, but it is possible to obtain a mortgage with a different term time depending on what you can agree with a lender.
In return for a lender financing your purchase, they will use the property that you are buying as collateral to secure the loan in case you are unable to keep up repayments, in which case the lender can “repossess” the property from you. So, although you purchase a property on completion day, the title deeds to the property are held by the lender until you have fully paid back the mortgage.
How can you tell if you can afford a mortgage?
The key to deciding on the appropriate mortgage level right for your circumstances is not to overextend yourself with the mortgage repayments. Put differently, don’t bite of more than you can chew. An important consideration to factor into your assessment is that whatever figure you come up with, it won’t stay the same because of:
- Interest rates
- Mortgage terms
This means, for a comfortable margin to live with, it’s not advisable to calculate your payable monthly costs based on the lowest possible amount. For example, if you decide that you can afford the house of your dream but only just manage to make the monthly repayments by a slim margin, what if we have an interest rate rise, as we will likely do in the foreseeable future? This means that you will have to pay more each month to buy your house. A small percentage increase in interest rates can result in a significant increase in cost, which can potentially push you over the financial edge.
The margin for financial comfort and safety should also consider other costs that are unlikely to stay the same. Take utility bills, for example. You’ve probably noticed that the cost of energy has risen sharply in 2021, whether at the fuel pump or the cost of gas and electricity. Indeed, we are currently living in a time of precarious inflation, with the cost of living rising across the board. And then there’s always an unexpected cost that will turn up and take you by surprise, such as an expensive car repair. A good start to carrying out your financial calculations is to use the Government’s Mortgage Affordability Calculator, which will give you a good idea of what you can realistically afford to borrow without getting yourself into financial trouble.
As a rough guide, lenders will typically agree to mortgages up to about 4.5 times your combined salary (if buying with someone else). The lender will also want to know things like are you employed or self-employed, and do you have income from any other sources.
When going to speak with a mortgage advisor, be prepared. They will require from you proof of income (pay slips, bank statements, tax returns, etc.), a breakdown of your outgoings, including any existing debt that you must service. Your credit score and financial history will be scrutinised, something that you can do yourself prior to the meeting so you don’t have any unpleasant shocks.
In short, the lender will want to be satisfied that you will be able to meet the monthly mortgage repayments but also have enough financial room to manoeuvre so you don’t get into trouble.
Securing a mortgage
You can directly approach a bank or building society for a mortgage to discuss what they are willing to offer. If you do, it’s best to shop around to see what other deals you can get from other lenders. Alternatively, you can approach a mortgage broker or an independent financial advisor to discuss all your options. If you decide on this route, bear in mind that they will likely charge a fee for their services. However, if they help you find the best deal available, these fees can be offset against what you can save.
The deposit is what you pay upfront towards the price of the property and is typically at least 10% of the value of the property. Of course, you can pay down a larger deposit if you are able to, which means you can probably get a better deal from your lender since their risk is reduced. The more you can pay in, despite the fact that the less you will have to borrow and the less interest you will have to pay back.
The amount of deposit you pay down will determine how much of the property you own at that point. For example, if you paid a £25,000 deposit on a £250,000 home, you would own 10% of your home. This means the mortgage is secured against the other 90% that you don’t yet own. This is the “Loan to Value,” or LTV.
Mortgage application preparation
To get the ball rolling, you will first need to establish a budget and make sure your finances are in order. To establish your budget, you will need to calculate how much you will be able to pay each month on repayments after you have taken all other expenses into account. Don’t leave anything out, no matter how tempting it is. Be realistic.
A credit check can help you determine in advance if there are any potential obstacles preventing you from getting a mortgage, and a credit check can help you with this. There are various services available, and some of them will charge you a fee to do this. Alternatively, you can follow the free advice set out by the Money Saving Expert on how to go about this.
You should double-check that all the information is valid and that there are no unresolved issues. Additionally, it’s important to ensure that you aren’t affiliated with someone who is no longer a part of your life, such as a former spouse or family member. If their credit history is not good, it may affect your credit score. Bankruptcies and missed loan payments can remain on your credit report for up to six years. You could be delayed in your mortgage application until your credit report has cleared up if you have any of these blemishes.
Paperwork and documentation preparation
You will have to supply the lender with various documents that they will require to fully assess your eligibility for a mortgage. Preparing this documentation will give you advance warning of anything that needs rectifying or updating, such as an expired passport. Lender will want to see originals and copies of the following:
- Proof of current address. A passport or driving licence usually suffices. They may also ask for previous addresses going back several years.
- Proof of salary and other income. This includes pay slips, bank statements, tax returns, and investment returns.
- Bank statement for at least 6 months.
- Copies of utility bills. Gas, electric, phone.
- P60 from employer (if relevant). For self-employed, tax returns.
- Proof that you have the deposit ready.
To save time and prevent delays, make sure that the information is up-to-date and accurate and that it matches what is on your mortgage application. You would be surprised how often this is overlooked and causes unnecessary delays and stress.
An introductory note on the main types of mortgages is in order, so when your lender mentions them, you will already have an idea of what they are.
- Fixed rate mortgage. The mortgage rate is fixed for a specified time, normally between 2 and 5 years. Your repayments won’t change in this period no matter what fluctuations you see with interest rates. This mortgage is typically offered to first time buyers based on lower-than-average rates.
- Tracker mortgage. Interest rates are based upon the Bank of England’s base rates, hence “tracker.”
- Standard Variable Rates Mortgage (SVR). The rates are determined by the lender, sometimes based upon the BoE base rates, but sometimes with other considerations.
- Interest only mortgage. Not as common as the above and come with higher risk. You only pay of the interest during the 25-year term, and the principal is paid up at the end. Some buy-to-let property investors use these mortgages to gain high rental returns.
- 95% mortgages. These mortgages are where the borrower only pay 5% deposit instead of the usual minimum of 10%. These come with various restrictions.