If you’re thinking about getting on the property ladder then you’re probably scratching your head about where to start with a mortgage.
This guide looks at the different types of mortgages available, what you’ll need to do before you apply and what to do about home insurance.
The first thing to consider is what type of mortgage you want. The two main types are repayment mortgages and interest-only mortgages.
A repayment mortgage repays the capital on the loan as well as the interest. In the earlier years the share of the payment towards the capital is small but it will increase as the term of the mortgage decreases so it will chip away at your debt over time. If you were to keep your mortgage for the full term, you would owe nothing to the lender at the end of the term.
For first-time buyers, it’s almost impossible to get your hands on an interest-only mortgage with the current lending criteria, but that could change at any time. Essentially, it does what it says on the tin. If you borrow £200,000 with an interest rate of 5%, it will cost you £10,000 a year – you only pay back the interest.
You will still owe the £200,000 throughout the lifetime of the mortgage term so you will never pay off any of the debt (unless you make overpayments), and at the end of the mortgage term you would still owe £200,000.
Once you’ve decided between a repayment mortgage or an interest-only mortgage, you then have the option of a fixed-rate mortgage or a variable rate mortgage.
A fixed-rate mortgage will fix your interest rate regardless of changes to the UK economy. So if you start out with a 5% interest rate on your mortgage, you’ll usually keep that rate for the specified offer rate provided by your lender. A fixed rate usually reverts back to the lender Standard Variable Rate (SVR) after the offer period is over.
A variable rate mortgage will usually move the interest rate up and down which could change your repayments month on month. The main cause of this is due to changes in the UK economy, but other factors do impact. Variable rate mortgages are more complicated and fall into three categories:
- Trackers – the rate of your mortgage is fixed to an economic indicator, usually the Bank of England base rate
- Standard variable rates – a mortgage lender has a standard variable rate which roughly follows the Bank of England base rate. This offer is not normally offered to new customers
- Discount rates – a discount is applied to the standard variable rate a mortgage lender offers. This discount is normally limited to a specific time period.
Repayment charges are usually applicable while in a special rate offer so be careful not to tie yourself into a deal for too long if you think your circumstances might change or you plan to move on in the future.
If you’re not sure how much you can borrow, use a mortgage calculator to work out your monthly outgoings including the repayment and interest repayment.
What do I need to do before I apply for a mortgage?
First things first, get your hands on your credit report online to check your credit score. Three of the main companies in the UK that provide credit reports are:
ClearScore offers free access to your credit score and you check this as often as you like without affecting your credit rating or score. If your score isn’t looking great don’t panic, there are ways for you to improve it. Check out ClearScore’s handy guide on improving your score.
Prepare proof of income - If you’re self-employed you’ll be asked to provide your accounts and bank statements and if you’re employed you’re normally asked to give three months’ worth of payslips and bank statements
Reduce your debts - This will show a mortgage lender you can manage your finances responsibly and they’ll be more likely to lend to you
Save as much as you can for a deposit - The bigger the deposit the bigger the choice of mortgages that will be available to you as it’s seen as a slightly lower risk to the lender so you’ll get better rates. Read our guide for tips on how to get your deposit together
Make sure you take all of the fees that coincide with a mortgage into consideration (there a quite a few to be aware of) We have a handy guide about the true costs of buying a home which will give you a good understanding of all the costs involved with buying a property. The main charges to look out for when setting up a mortgage are:
- Arrangement fee – this could be a fixed fee from your lender or a percentage (roughly 1.5%-2%) of your loan and can usually be added to the loan
- Valuation fee – this will cover the cost of an inspection of your new property. Budget around £250 for this. Some lenders offer an upgrade on a valuation to a Homebuyers Report which is more in depth or a full structural survey at an additional cost
- Legal fees – a solicitor will be able to handle all of the legal aspects of buying a new property for you. The Money Advice Service will be able to provide more information about legal fees
- Stamp duty – this will depend on the price of the property. If your property costs less than £125,000, you won’t have to pay anything. Find out all of the rates here.
Sometimes it is worthwhile looking at the overall cost of the mortgage rather than just the best interest rates. It can be cheaper to go for a higher interest rate with lower fees than a lower interest rate with more hefty fees upfront. A mortgage adviser should be able to advise you on this; to find a good mortgage advisor in your area use the Unbiased website.
Do I need home insurance to get a mortgage?
Buildings insurance will cover the cost of fixing your home if it’s damaged and it’s normally a condition of your mortgage. An important thing to take note of is that you don’t have to take out a policy with your mortgage provider; shop around to find the best home insurance policy that suits you.
Once you have moved into your new home you should consider adding contents insurance to your policy too - this will protect all of the belongings in your new home. Try using our contents calculator to get an estimate of what your contents are worth as undervaluing your contents could leave you at risk of being underinsured.
In addition to home insurance, mortgage advisors strongly recommend first-time buyers take out life insurance and critical illness cover.