If you’re looking to buy your first home or are selling up and buying somewhere bigger, then chances are you’re going to need a mortgage.
What is a mortgage?
A mortgage is a loan offered by high street banks, building societies and other lenders specifically to help people buy their own homes.
The money borrowed will be paid off over a number of decades and repaid in full by the time you reach retirement.
A mortgage normally has a 'term', which is the number of years it is expected that you’ll take to repay it.
The average mortgage term used to be 25 years, but in the face of higher mortgage rates, increasing numbers of borrowers are taking out mortgage terms of 35 or even up to 40 years.
Once you’ve taken out a mortgage, you use the money to buy your home and then repay the bank or building society a monthly sum, with interest added on.
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How does a mortgage work?
A mortgage is an agreement to accept a sum of money in relation to a home you want to buy.
The loan is offered on the premise that you repay it with interest (a repayment mortgage) or you pay just the interest (an interest-only mortgage) every month.
The value of your home is set against the loan, so if you miss mortgage repayments your home could be at risk and ownership of the property may default to the lender.
Before issuing a mortgage loan, the lender will conduct a valuation of the home you’re buying. They will only agree to offer the mortgage if they see that their valuation of the property reflects what you’ve agreed to pay for it.
What to do if the home you're buying gets down valued by the bank
Deposit
When you apply for a mortgage, you’ll usually need to have already saved up a deposit. This money is a percentage of the value of the home you want to buy.
So, if you’re buying a £250,000 home, a deposit of 10% would be £25,000.
The size of the deposit you have, as well as the value of the home you want to buy, determines what’s known as the 'loan-to-value' ratio.
So, a loan of £225,000 from the bank with a £25,000 would be 90% loan to value ratio.
The larger your deposit, the lower your loan-to-value ratio (read our full guide here).
And the lower your loan-to-value ratio, the larger the number of mortgage deals available to you.
That said, 95% mortgages are available and offered by major high street lenders.
Interest rates
Banks and lenders are more likely to give you a better interest rate for your mortgage if you have a lower loan-to-value ratio (making borrowing cheaper).
This is because the lower the loan amount compared to the value of the home you’re buying, the lower the risk for the lender providing your mortgage.
The amount of interest you pay over the course of your mortgage term depends on the rate offered to you by your lender, the length of the mortgage term and the type of mortgage you choose.
Some lenders charge a fee upfront to arrange a mortgage. Others roll the cost of arranging your mortgage into the amount you are borrowing.
The rate of interest offered by banks usually follows what’s happening in the economy.
So, if the Bank Rate (the rate the Bank of England charges other banks and lenders to borrow money) is going up, mortgages will be more expensive. If the Bank Rate is low, mortgage rates will usually be cheaper.
Find out more about the price of mortgages in 2024.
Types of mortgages
There are different types of mortgages. The most common is a repayment mortgage, where you repay the loan as well as interest every month.
An interest-only mortgage means you only pay towards the interest on the sum you’ve borrowed every month.
If you have an interest-only mortgage, you repay the loan in full at the end of the mortgage term. This might mean selling the home to repay the loan in full.
Find out more about the differences and pros and cons between a repayment and an interest-only mortgage in this guide.
Here is more information about the various types of repayment mortgages, from fixed rate to tracker to standard variable.
You also need a special type of mortgage to buy a home to rent out. Find out more about buy-to-let mortgages here.
How does applying for a mortgage work?
There are several different ways to apply for a mortgage.
If your financial circumstances are straightforward (ie you have a deposit saved, a permanent job and a decent credit score) you should be able to apply to a high street bank or building society either online or over the phone.
You can also make an appointment with your bank manager and apply for a mortgage in-person at a bank or building society branch.
Some banks or lenders don’t have physical presences on the high street and other products are offered as 'online only'. So it’s worth doing your research.
If your circumstances are more complicated (ie you are self-employed or you have had a poor credit score in the past) it might make sense to speak to a mortgage broker instead of applying directly to a lender.
A mortgage broker has access to a range of products that aren't always available on the high street and they can advise you as to your chances of securing a home loan.
Some mortgage offers require you to pay a fee to secure them. In some cases you can pay more to get a better interest rate.
Some lenders also offer to roll in the cost of the mortgage arrangement fee into the amount you are borrowing.
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What’s a remortgage?
Remortgaging means you either take out a new loan with your existing lender or find a new bank or building society to give you a new mortgage.
You might remortgage in order to get a better interest rate. For example, if the value of your home has increased since you bought it, you could get a much better deal as your equity stake in your home will have increased.
Or you might want to borrow more money against your home in order to pay for renovation works or extensions.
If you are moving home you can sometimes 'port' your existing mortgage to your new home. You might then decide to remortgage later.
When you sell up you usually repay your existing mortgage in full and so need a new mortgage for the home you're buying.
What’s a mortgage agreement in principle?
A mortgage agreement in principle is a statement from a bank or lender saying they're willing to lend you a certain amount for a new home.
Most estate agents prefer buyers to have an agreement in principle arranged before you can put in an offer, as it shows that you're a serious buyer.
To arrange a mortgage agreement in principle, you'll need to provide a lender with your financial information, so that they can give you an indication of how much they're willing to lend you.
A mortgage in principle is not the same as a mortgage offer: it is an indication of how much a lender is willing to offer you, while a mortgage offer is official confirmation from a lender that they're willing to provide you with a mortgage.
In order to get an agreement in principle a lender will conduct 'soft' checks on your financial status, which won't affect your credit rating.
Once you’re in a position to secure your mortgage and get it formally arranged, these checks become more rigorous.