Mortgages explained

Having difficulty getting your head around mortgages? This will help.

This is Tom. Tom likes gigs, going out with his mates and manning the barbecue. He wants to buy a house. But houses cost, like, hundreds of thousands of pounds!

Tom’s home owning friends talk about “deposits”, “loan to income ratios” and “mortgages”. Tom wants to know what this all means so that he can buy a place of his own, get a grill for the garden and enjoy a rent-free life.

What is a mortgage?

Simply, a mortgage is a loan given to somebody by a bank or building society to buy a house that is usually repaid over a term of 25 to 35 years.

A mortgage is different from other types of borrowing, like personal loans or credit cards, because if you cannot repay it, then the property will be repossessed and sold to repay the amount you borrowed.

How much can I get on a mortgage?

Well, you will need to pay a “deposit” of around ten or twenty percent of the house price upfront. To work out how much you will need to borrow, simply subtract your deposit from the price of the house you want to buy. Then that is how much you need to take out as a mortgage.

A mortgage lender then calculates whether you can afford to borrow that amount based on your Loan To Income ratio. Your LTI ratio is a measurement of how much of your monthly income goes towards paying off debts such as your mortgage.

As a rule, a mortgage can be no more than four times your annual salary. Tom earns £20,000 per year, so he can get a mortgage of four times £20,000 which is £80,000.

You might also hear the term Loan to Value ratio. Your LTV ratio is a percentage showing the value of your mortgage relative to the value of your property. So if Tom buys a property worth £100,000 with his £80,000 mortgage, his LTV ratio would be 80 percent.

What do I need to get my mortgage approved?

You need proof of regular income. This includes any investments, savings, or child maintenance you may receive. You then need to declare how much do you spend each month. This includes everything; food, travel, bills, credit card payment and going out.

It is important to be honest. If you’re not, you may find yourself unable to afford either your mortgage payments or your living costs. Also bear in mind that if you miss a mortgage payment, your new home could be repossessed.

The lender will then carry out a credit check. How is your Credit Score looking at the moment Tom?

Tom: Looking pretty good, thankfully.

The mortgage lender may also perform a stress test to assess whether you could still cope with payments if you got sick, were made redundant, or had a baby.

What mortgages are out there for someone like me?

A tracker mortgage is a mortgage where the monthly payments change depending on the Bank of England interest rate. If interest rates go up, your monthly mortgage payment goes up, but if they go down, your monthly mortgage payment goes down.

A fixed rate mortgage means that the amount you pay back each month is fixed for a short term of usually between two and five years regardless of what the interest rates are doing.

What mortgages are available to first-time buyers?

For newbies like you Tom, there is the Help To Buy Equity Loan or the Help to Buy ISA.

With a Help To Buy Equity Loan, you provide five percent of the property’s value and the Government lends you a further twenty percent so that you have a deposit.

A Help to Buy ISA is a tax-free savings account to help build up your deposit. For every £200 you put in, the government adds another £50, up to a maximum of £3000.

What if I want a mortgage to buy a place to rent out?

You can get a Buy To Let mortgage where the monthly payments are based on how much rent you will receive from the property.

OK, so I know how much I can afford, I have found a place I like, what happens next?

Do your research. Visit money comparison sites to see what mortgages are out there. Then visit your bank’s mortgage advisor, they will able to guide you through securing your mortgage and help you fill out the mountain of paperwork involved.

Tom: Yay, mortgage approved! In a few months, I’ll be grilling burgers in my own garden.

No problem Tom. Just remember to pay your mortgage each month before you buy your burgers.

Tom:  Will do.

WARNING: Your home may be repossessed if you do not keep up repayments on your mortgage.