What is a mortgage?
Last updated: 08/04/2021
Remember: When you get a mortgage, you’ll need to make sure you can afford the repayments each month, if you can’t keep up with the repayments, your home may be repossessed.
Simply put, a mortgage is a big loan: you borrow money to buy a property over a set period of time.
You have to pay interest on what you owe, and this is known as an interest rate.
Getting an affordable rate is an essential part of finding a mortgage that’s right for you. So, here is an introduction to what you need to do.
- What is an interest rate?
- What mortgage rate will I pay?
- Fixed-rate mortgages
- Variable-rate mortgages
- Standard variable rate mortgages
Interest is the cost of borrowing money, and it’s shown as an annual percentage of the loan.
Understanding how interest rates work will help you choose the right mortgage and ensure you’re prepared for any interest rate changes.
The Bank of England sets the bank rate for the UK, which in turn can influence the interest rates set by mortgage lenders.
The higher the interest rate, the higher your monthly repayments.
A quick note on jargon: when comparing mortgage rates, you’ll come across loan to value (LTV) - this is essentially the size of mortgage a lender is prepared to offer you in relation to the value of the property. LTV is calculated in relation to the value of the property or the purchase price, whichever is lower.
How much you pay back each month on your mortgage is determined by several factors:
- How much you’ve borrowed in the first place
- The rate of interest charged on your mortgage
- How long your mortgage is for
- The type of mortgage you’ve chosen, fixed or variable rate
Usually, the bigger your deposit, the lower the interest rate you’ll need to pay and the cheaper the mortgage, however there are some mortgages where this is not the case, these include shared ownership, help to buy and shared equity. Bear in mind too that there will be other fees and exit charges, in addition to interest payments.
So, with a fixed-rate mortgage you get certainty over how much you’ll pay each month. However, to pay for that security the interest rates on fixed-rate mortgages tend to be higher than those on variable rate mortgages.
With fixed-rate mortgages the interest rate is set in stone for a certain period of time, which means your monthly repayments are fixed too.
This can be for as little as two years or as long as 10 years.
Advantages of fixed rate mortgages:
- Certainty about how much you’ll pay each month, helping you to budget
Disadvantages of fixed rate mortgages:
- Interest rates on fixed-rate mortgages can be higher than on variable rate mortgages
- If interest rates fall, you won’t benefit as your rate is fixed
- You’ll be charged if you want to leave the deal before the end of the fixed period
Whatever type of variable rate mortgage you choose, it’s important to budget ahead for any potential rise in interest rates.
With variable rate mortgages, the interest rate can change at any time.
There are several types of variable rate mortgages, including trackers and discounted. With a tracker mortgage, the rate is set at a certain percentage above the Bank of England’s Bank Rate, so your interest rate will change automatically as the Bank Rate Changes. A discount mortgage, gives you a set percentage discount from the lender’s Standard Variable Rate. The lender sets the SVR and can choose when to change it.
Some variable rate mortgages have floor rates which means that you may not see a difference in your mortgage rate if the Bank of England base rate or the Standard Variable Rate drop. The floor rate is the lowest your mortgage rate can go.
Advantages of variable-rate mortgages:
- Your mortgage rate could decrease. If it does, then it is likely that your mortgage payments will too.
- Initially, interest rates on variable rate mortgages tend to be lower than those on fixed rate mortgages.
Disadvantages of variable-rate mortgages:
- Your mortgage rate could increase. If it does, then it is likely that your payments will increase too.
- You may be charged if you want to leave your mortgage deal early.
With most mortgage deals, your interest rate will revert to your lender's standard variable rate (SVR) after the initial period comes to an end.
Each lender sets their own standard variable rate and they tend to be higher than other mortgage rates.
Don’t solely focus on the rate
While rates are really important when choosing a mortgage, there are other considerations too, including fees and early repayment charges. Also, consider other regular costs such as utility bills and council tax. It’s important not to over-stretch yourself and feel comfortable you’ll be able to pay your mortgage every month.
Click on the sections below to explore what you need to know at each stage of your home buying journey: