Taking out a mortgage for your new home? Here's our guide to mortgage types and costs.
Sorting a mortgage for your new flat or house will feel like one of the biggest jobs to tick off your ‘to-do’ list.
Getting accepted for a home loan is no mean feat given the strict rules on affordability now in place.
But the hard work does not stop here. As a mortgage will probably be your biggest financial commitment, it’s important to get to grips with what your monthly payments are going to be.
How are mortgage repayments calculated?
When it comes to understanding mortgage repayments, there are several factors to take into account:
The mortgage debt – this is the loan amount you have borrowed from the bank.
Mortgage term – this refers to the length over which you have opted to repay the mortgage. Typically, this is 25 years.
However, some first-time buyers may opt for a longer mortgage with some terms stretching for as long as 35 years.
The advantage of a longer term mortgage is that your monthly repayments will be lower. The downside is it will take you longer to clear the debt. Plus you’ll pay more in interest in total.
Annual interest – this is the rate of interest you will get charged by your lender.
Fees to take out the mortgage – some of the very cheapest mortgage rates come with a sting in the tail in the form of a hefty ‘arrangement fee.’
This is a charge levied by the lender for setting up the deal. If you opt to add this to your mortgage, you will need to take this into consideration when working out your mortgage repayment.
Note that arrangement fees become more significant on short-term deals.
For example, a £2,000 fee on a two-year fixed-rate mortgage works out at £1,000 a year. But this same fee on a five-year deal will only be £400 a year.
Repayment mortgage or interest-only mortgage
Another important factor to take into consideration when calculating your mortgage repayments is whether you have opted for a repayment deal or interest-only deal.
- Repayment – this is the most popular and widely available mortgage repayment option. With this type of mortgage, you pay back a small part of the loan (or capital) as well as interest each month.
This means you are guaranteed to pay off the whole loan at the end of the term (provided you meet all your repayments). Once your mortgage is paid off, you will own the property outright.
- Interest only – with this type of mortgage you initially only pay back the interest each month.
While your monthly payments will be less than if you’d opted for a repayment mortgage, you will still owe the same amount at the end of the term as when you took out the mortgage.
Bearing this in mind, you need to have a plan for paying off the capital at the end of the term. Lenders are far more nervous about interest-only loans and will also want to be sure you have a repayment strategy in place – such as an ISA, investment fund or pension.
Doing the sums
Once you have all the above information at your fingertips, you can work out what your monthly repayments will be.
Interest-only mortgages can be worked out as follows…
(Total amount borrowed x interest rate) ÷ 12 (number of months in the year).
If you borrow £200,000 interest-only at 5% over 25 years, your monthly payment will be (£200,000 x 0.05) ÷ 12 = £833.33.
But remember, because it is interest-only you still have to pay back the full £200,000 at the end of the term.
Repayment mortgages are more tricky to work out because as well as paying the interest you nibble away at the capital every month too, with the monthly costs then averaged out over the entire period.
Zoopla’s running costs – which you can find below any property when using the search on this website – can help you.
It allows you to enter the purchase price, deposit, repayment term and interest rate and then calculates the monthly repayment figure.
What type of mortgage?
Once you’ve settled on a repayment mortgage (or an interest-only mortgage), you need to decide what type of deal you want. You can choose between a fixed-rate and a variable-rate mortgage.
Fixed-rate mortgage – with a fix, the interest rate is fixed over time and does not change. You will know exactly how much you are paying each month, regardless of any changes to the base interest rate made by the Bank of England.
Even if your lender’s standard variable rate (SVR) goes up, you will pay the same amount until the end of the fixed term.
Variable-rate mortgage – with a variable mortgage, such as a tracker or discount deal, the interest rate – and therefore your monthly payment – can go up or down at any time.
Which type should I choose?
If you’re happy with the idea that you could afford rates going up, you may want to consider a variable, discount or tracker, as this could work out cheaper overall.
However, if you’re unsure about whether you would still be able to afford your monthly payments if the interest rate goes up, opting for the peace of mind of a fixed-rate deal makes sense.
The attraction of fixing your mortgage rate is the certainty it brings to your monthly mortgage repayments. This can make budgeting a whole lot easier.
For more information on finding the right deal, visit our partner, Money.co.uk.
If you’re unsure about the best option for your needs, you may also want to seek help from a broker.
How long to fix for?
If you’re considering a fixed-rate mortgage, you will have to opt to fix your rate for a set time. This could be for a period of one, two, three, five or even 10 years.
The longer your fixed term, the longer you are locked into that interest rate. The issue is that if you go for a 10-year fix but then need to exit during that time, you could face hefty early repayment charges.
If you are a first-time buyer, it's likely that your circumstances will change a lot in the next 10 years, so you are probably better off opting for a shorter-term deal.
Two-year and five-year fixed term mortgages tend to be the most popular.
Read more at: Your mortgage: how long should you fix for?
What about the Standard Variable Rate (SVR)?
Remember that when you come to the end of any fixed term, you will move on to your lender’s SVR – unless you move to a new mortgage deal at that time.
If you do end up on your lender’s SVR, you need to be aware that the rate can go up and down whenever the lender decides to do so.
If the lender puts its SVR up, your monthly payments will increase. If the SVR falls, your monthly repayments will fall too.
While SVRs loosely follow movements in the Bank of England base rate, they do not have to.
Whatever you do, be very careful about sitting on your lender’s SVR for any period of time, as an SVR is usually costly.
If you stay put, you will probably find you are paying way over the odds on your monthly mortgage repayments.
The key is to take action and switch to a new deal, as this will reduce the amount you have to pay each month.