What is a mortgage?
A mortgage is a loan secured against your home. Like all loans, the terms of a mortgage require you to pay back to the lender (the bank or building society) the amount borrowed, plus interest, over the agreed mortgage term. As a mortgage is a secured loan, if you can't meet the repayments, the lender has the right to sell your home to recover the money you owe.
How a mortgage works
How a mortgage works differs depending on the type of mortgage you're looking at. However, the basis of how a mortgage works remains similar from one type to another. When you take out a mortgage, it will have an agreed interest rate which, depending upon the mortgage type, might be fixed or variable. You will have to pay your lender the interest on the mortgage every month and, if it is on a capital repayment basis, repay part of the capital too.
This interest rate may be for an initial period, for example 2 or 3 years, after which term the mortgage rate will revert to the lender's Standard Variable Rate or other specified rate for the remainder of the entire mortgage term or until you remortgage.
How much can I borrow for a mortgage?
How much you can borrow for a mortgage depends on several different factors. The vast majority of lenders now use affordability as the basis for deciding how much they will lend you. Their decision on how much you can borrow for a mortgage is based upon on your ability to repay the mortgage after taking account of your income and expenditure, such as regular commitments and your living expenses.
Your application may also be deemed unaffordable if your income is too low or your level of unsecured debt is too high. Different lenders have different methods of assessing affordability which are regularly reviewed and subject to change.
As a result of this, it is no longer simply a case of multiplying your income by three and a half times (or, in the case of joint applicants, three and a half times the first applicant's income and one times the second applicant's income) when asking 'how much can I borrow for a mortgage?' However, using these income multiples may still give you a very rough idea of how much you might be able to borrow.
Factors which affect how much you can borrow
When deciding upon whether they will lend to you in principle and, if so, how much you can borrow for a mortgage, the lender will take account of the following factors:
- Your age (You have to be at least 18 to get a mortgage. If your mortgage term is likely to extend into your retirement you will have to demonstrate that you can afford the mortgage when you retire. If you will be over the age of 75 by the end of the mortgage term it is very difficult to get a standard mortgage)
- The amount of your deposit relative to the anticipated property purchase price or valuation
- Your income
- Your outgoings
- You credit history.
Bear in mind that the best mortgage rates tend to be limited to those who have a deposit or equity of 25% or more, equating to a Loan to Value of up to 75%). Mortgage interest rates tend to become progressively more expensive as your deposit reduces below 25% of the property's value.
As a starting point, establish how much of a deposit you can raise, taking into account the initial costs of purchasing a property, before obtaining a rough idea of how much you might be able to borrow with a mortgage.
The cost of a mortgage is largely determined by the interest rate offered by the lender, which varies from mortgage to mortgage. When calculating mortgage costs, it's important to consider the following factors:
• the duration the interest rate is offered for
• whether the interest rate will change over the initial period
• how changing interest rates may affect your repayment costs.
Calculating the cost of a fixed rate mortgage over the initial rate period is relatively straightforward, since the interest rate, and therefore, your monthly repayments will remain the same. The cost of variable rate mortgages is more difficult to calculate over the initial period, as the interest rate is likely to fluctuate.
The true cost of a mortgage over the mortgage term is more difficult to establish, since even fixed rate deals will revert to a variable interest rate once the initial period expires and it is impossible to accurately predict what will happen to interest rates over a long period. However, whether calculating mortgage costs over the life of the mortgage or an initial period, you should also take into consideration the fees and charges involved in buying a house and arranging a mortgage.
How much is a mortgage deposit?
The size of your mortgage deposit relative to the purchase price of your property will determine what interest rate you will pay and whether you are able to get a mortgage in the first place. How much a mortgage deposit is depends on the property price but also upon your financial circumstances since increasing your mortgage deposit will reduce the amount you need to borrow and minimise the cost of a mortgage.
There are currently relatively few mortgages available that will lend more than 90% loan to value, so to get a mortgage you will generally require a deposit of at least 10% of the property purchase price. To buy a property for £175,000 this would mean raising a deposit of at least £17,500.
The lowest mortgage rates tend to be limited to buyers who are able to raise a house deposit of at least 25% (a 75% loan to value ratio), which equates to £43,750 on a £175,000 property. It's understandable therefore that the most attractive mortgage rates are beyond the reach of most first time buyers.
Credit scoring and your mortgage
A poor credit rating can severely hamper your chances of getting a mortgage, making it vital that you understand how to improve your credit score if needed. If you have a history of County Court Judgements (CCJs) , arrears and defaults it is incredibly difficult to get a mortgage, or indeed any other form of mainstream credit.
For more information on your credit score, see our credit scoring guide.
Repayment vs. interest only
Interest only mortgages
With an interest-only mortgage, your monthly mortgage repayment only pays the interest on your mortgage, meaning that you're only repaying the cost of borrowing the money and not the sum of the loan itself. Quite simply, with a 25 year interest only mortgage of £175,000, you would still owe £175,000 at the end of the mortgage term. It is therefore essential that you set up a means of paying for the cost of the property itself such as an ISA, a unit trust, an OEIC, an investment trust, an endowment, a pension or another type of savings plan. Your lender will want to see ongoing evidence of this 'repayment vehicle.'
Repayment mortgages are a more popular option with most house buyers. With a repayment mortgage (sometimes called a 'capital repayment' mortgage), you pay off the interest and part of the amount which you have borrowed each month. Therefore, at the end of your mortgage term, you won't owe anything and will own your property, providing you have made all you required monthly repayments on time.