What is a Mortgage?

A mortgage is a loan from a bank or building society used for the purchase of a property. A mortgage is paid back with interest over a period of several (usually 25+) years. Until the mortgage is repaid, the loan is secured against the property, meaning the lender can repossess it if you fall behind on payments.

Deposits and LTV

To get a mortgage, you have to pay for a portion of the property yourself upfront: this called the deposit, represented as a percentage of the total value of the property. A 10% deposit on the average British house would be around £24,000.

A mortgage provider lends you the remainder of the cost of the property—expressed in a percentage as the loan to value (LTV) ratio. The higher your deposit and the lower your LTV, the more mortgages you’ll be able to access, and the less you’ll have to pay overall in interest.

Loan to Value Diagram

Types of Mortgage: Reasons for Borrowing

The terms of your mortgage will depend largely on the reason why you're trying to borrow. There are four basic types of mortgage available:

Home Movers

Most mortgages are taken out by people looking to sell up their current house and move to a new one. The kind of mortgage you’ll want will depend on a few things. If you’ve already paid off your mortgage on your existing property, then you may be lucky enough to be able to purchase the new property outright. Alternatively, to keep your cash flow positive, you might want to offer a high deposit and borrow the bare minimum.

If you’ve still got some way to go on your present mortgage, you’ve got a couple of options available. You can use some of the cash from the sale to pay off your existing mortgage, and use the remainder (the equity) for a deposit on a new one. In this case, you might face early exit fees. If exit fees are high, you can contact your lender and arrange to port the mortgage over to the new property – though not all lenders will let you do this.

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Buy-to-Let Mortgages

A buy to let (BTL) mortgage is a loan taken out to purchase a property that you’re going to rent out. Their monthly rent covers your mortgage payments – as well as other costs and (hopefully) some profit. Most buy to let mortgages are interest-only, meaning your monthly payments only cover interest on the loan and and the principal of the mortgage (the amount borrowed) will not go down over time. At the end of the mortgage term you then have to pay off that balance, generally by selling the property.

With a repayment mortgage, your monthly payments cover both the principal and the interest so at end of the term of the loan you’ll own the property outright. Monthly payments on repayment mortgages are higher than on interest only mortgages so the amount you’re taking in in rent has to be high enough to cover them. Either way, most buy to let mortgages require a deposit of at least 25%.

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First Time Buyers

First time buyers, who won’t have equity in a previous property to use as a deposit, can access specialised mortgages only available to people who have never before owned a property. These mortgages can be secured with as little as a 5% to 10% deposit. However, mortgages with high LTV come with high interest rates.

Help to Buy is a government scheme aimed at helping first time buyers with small deposits get onto the property ladder. Help to Buy offers equity loans of up to 20% of a home’s value (40% in London). These loans, which are interest-free for five years, let buyers access mortgages with lower LTV % and lower interest rates. Help to Buy is targeted at first time buyers but is technically available to anyone purchasing a home for less than the threshold price and who intends to live in that home full-time.

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Remortgaging

If you have a mortgage on a home but think you can save money with a mortgage, perhaps from a different lender, you can remortgage your home. Remortgaging is taking out a second mortgage on the value of your home that hasn’t yet been paid off; the new mortgage is used to pay off the old one.

Many mortgages come with promotional, introductory interest rates that expire after a few years. The end of the promotional period is the time when many people remortgage, to take advantage of lower interest rates elsewhere. If you remortgage at that point you often won’t be subjected to early repayment charges. You may also want to remortgage to take advantage of a new fixed rate mortgage, which will guarantee you a specific interest rate for a period of time.

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Types of Mortgage: Interest

The terms of your mortgage will depend largely on the reason why you're trying to borrow. There are four basic types of mortgage available:

Fixed Rate Diagram
Fixed Rate Mortgages

A fixed rate mortgage comes with an interest rate that remains constant for a period of one, two, three, five, or ten years. This means that your monthly payments are locked in for that term, regardless of any changes in the lender’s standard variable rate or the Bank of England’s base rate. After the fixed term is up, you’ll start paying your lender’s Standard Variable Rate, which will be higher. Many people take out a fixed rate mortgage with the intention of refinancing and switching to a product with a more favourable interest rate at this point.

A fixed rate mortgage will generally have a higher interest rate than you could obtain initially with a variable rate mortgage but it offers the stability of several years of unchanging monthly payments.

Variable Rate mortgage diagram
Variable Rate Mortgages

A variable rate mortgage is one with an interest rate that fluctuates. For a standard variable rate mortgage, the interest rates is set and changed by the lender. Traditionally, variable mortgages came with lower interest rates; this isn’t necessarily the case anymore and the introductory offers on some fixed rate mortgages can rival those of variable mortgages.

In general, however you can obtain a better interest rate by opting for a variable mortgage—but you have to be prepared to see it change. It’s a good option if you believe you could financially accommodate higher mortgage payments in the future or if you anticipate market circumstances will cause interest rates to drop.

Tracker Mortgages

A tracker mortgage is a type of variable mortgage with an interest rate that’s fixed a set amount above the Bank of England’s base rate and will change as that rate is adjusted. The Bank of England’s base rate is currently 0.75%, meaning a tracker mortgage that follows the base rate at 2% will have an interest rate of 2.75%.

Most tracker mortgages only track the base rate for a set number of years before reverting to the lender’s standard variable rate, which will usually be higher. You’ll often be hit with early repayment fees if you want to remortgage at this point. On the other hand, lifetime trackers continue to track the base rate until the end of the mortgage term. If the Bank of England’s base rate rises precipitously, dramatically increasing your monthly repayments, you’d be able to remortgage and pay off your lifetime tracker without incurring early repayment fees.