Mortgage Basics
So you are ready to get your first home, but where do you start? How do you go about getting a mortgage? What do you need to know before you apply? Here are some mortgage basics that can get you started.
What Is a Mortgage?
Knowing what a mortgage is will be the first step to finding the right one for your new home purchase. A mortgage is a loan that you receive to purchase property, usually a home. You will have set monthly payments that you have to make to the mortgage lender. If you fail to make your payments, the lender can repossess your home.
Your loan has two basic parts: capital and interest. The capital is the amount you borrowed. The interest is the money you will pay to the lender for the privilege of borrowing money. Your lender makes money off of the interest. Interest is usually represented by an interest rate.
When shopping for a mortgage, you must look at both interest rates and mortgage fees. Many lenders will charge fees for various actions taken with your mortgage. These fees increase the cost of your mortgage, and you need to know what they are before signing up for the loan.
The Rules of the Game
When you buy a property, you will need to place a down payment on the home. The mortgage will be used to pay the rest of the cost of the home. The amount of the down payment will affect how much your mortgage costs. Most lenders want you to put 20% or more down for the home. If this is not possible, you may end up paying mortgage indemnity insurance.
In order to have a mortgage, you will have to have insurance against theft, fire, store, or other disasters. Many lenders require you to have life insurance as well. This provides them with a guarantee that your surviving spouse or children will be able to pay off the property if you were to die before the loan comes to term.
When considering mortgage basics, you will also want to consider your interest rate. As you shop for a mortgage, you will want the loan with the lowest interest rate possible for your financial situation. You can choose either a fixed interest rate or a variable interest rate. The fixed rate will stay the same throughout the loan’s term, but a variable rate will rise and fall based on the actions of the Bank of England.
Choices, Choices, Choices
If you thought choosing a home would be hard, wait until you find out all of the choices you have when it comes to choosing a mortgage! The first thing you need to decide is how much you are going to borrow. This will be based on how much your lender is willing to lend to you, and how much you can realistically afford to repay.
Next, you will have to choose a term for your mortgage. A traditional mortgage runs for a 25-year term. However, if you choose a shorter term, you will have a less expensive mortgage in the long run.
A third choice you will have to make is the type of mortgage you want. You can choose a repayment mortgage or an interest-only mortgage. A repayment mortgage allows you to pay off your home one month at a time, owning it completely when you are done with the mortgage term. Interest-only mortgages only require you to pay the interest from month to month, but the capital is due at the end of the mortgage.
Interest is another choice you have. You can choose a variable rate or a fixed rate. Most variable rate mortgages have a fixed discount rate at the beginning of the mortgage term.
Finally, you will need to choose a lender. Your lender will be a bank, building society, or other lending institution. Choose a lender with a good reputation that offers you a best interest rate and a loan with few fees. Using an independent mortgage broker is a good way to know that you have found a quality lender.
How Much to Borrow
Deciding how much to borrow is not easy. Sometimes lenders will offer you far more than you can realistically afford. Use mortgage calculators to determine what your monthly payments will be with various mortgage structures.
Keep in mind that most lenders are willing to lend you three times your annual income. Also, remember that you will have to account for the capital repayment if you choose to use an interest-only mortgage structure. Make sure you do not end up in a mortgage that costs more than you can pay, because you will put your home at risk.
Proving Income
Lenders want to know how much money you make before they will approve a loan for your home purchase. Remember, you will typically be able to borrow around three times the amount you make each year. However, lenders would rather have some proof of your income instead of just taking your word for it.
If you are employed by someone, proving your income is easy. You will simply present your pay slips or your P60 form. However, many borrowers do not have confirmable income. Those who are paid with commissions or are self-employed, for example, may need to have additional income proofs. Three years of audited accounts are usually sufficient. Some lenders will offer self-certification mortgages, which allow you to simply state your income without written proof.
Understanding Your Interest Rate
Interest rates are sometimes tricky to understand. Interest rates contribute to most of the cost of your loan, so understanding how they work is essential to getting a good deal. One of the best ways to decide the type of interest structure to use is to watch rate trends. Most lenders set a standard variable rate that is 2% higher than the Bank of England’s base lending rate. Fixed rate mortgages are slightly higher than this.
When interest rates appear to be increasing, a fixed rate mortgage will help you lock in a good rate while they are still low. On the other hand, when rates appear to be dropping, a variable rate mortgage will allow you to take advantage of these continued drops. However, there is always a chance with a variable rate mortgage that the market could change and rates could increase.
Understanding Your Mortgage Term
Traditional UK mortgages are 25 years. However, you can choose just about any length of mortgage term when you get your loan. Most lenders will offer loans between 15 and 40 years in length.
The longer your loan, the lower your monthly payments will be. However, if you choose a long loan, you will pay more in interest over the life of your mortgage. The best strategy to save money in the long term is to get a loan with the shortest possible term that still gives you monthly payments that you can afford.
