This article is targeted at first time buyers who are looking to get their feet on the property ladder and explains how to obtain a mortgage.
Before calculating the size of the mortgage you need or speaking to lenders, it’s a good idea to quickly review the mortgage fundamentals.
(a) Mortgage security
Almost all of you will know already that a mortgage is a loan that you take out from a lender, such as a bank or building society, to help you buy property. The mortgage lender secures the loan against the property you buy, so if you don’t repay the loan as agreed it can take possession of the land and sell it to get its money back.
(b) Capital and interest
A mortgage loan is divided into two parts: (i) the capital (i.e. the money you borrow to buy your property), and (ii) the interest (i.e. the amount the lender charges you to borrow the capital).
(c) Types of mortgage
There are two main types of mortgage: (i) interest mortgages and (ii) repayment mortgages (which are also known as capital and interest mortgages).
If you choose an interest-only mortgage, your monthly payments to the lender cover the interest charged on the money you borrowed, but you do not pay off any capital. This means that your monthly payments are relatively low. However, you will still owe the capital at the end of the agreed mortgage term. If you cannot repay the capital, the mortgage lender can take possession of your property.
If you choose a repayment mortgage, your monthly payments will repay both capital and interest. Provided you keep up the payments, you are guaranteed to clear your mortgage debt by the end of the mortgage term and the property will then be all yours.
(d) Fixed rate and variable rate
There are two main ways that interest is charged on a mortgage: you agree to either pay a fixed rate of interest or a variable rate.
A fixed rate mortgage involves repaying a fixed interest rate for a specified period of time. After the agreed fixed rate period, the interest rate usually reverts to the lender’s variable rate. If you want to end the mortgage before the fixed rate period expires, you may have to pay an early redemption penalty, which is usually quite expensive.
Interest on a variable rate mortgage will fluctuate month-by-month depending on the Bank of England’s base lending rate. Every time the Bank of England raises its rate, mortgage lenders increase their standard variable rates. Lenders also reduce their rates when the Bank of England lowers its rate. Mortgage lenders do not, however, charge the same amount of interest as the Bank of England base lending rate — usually it’s 2% above the Bank of England rate.
(e) Loan-to-value ratio
The loan-to-value ratio is the value of your mortgage loan in relation to the value of the property. So, for example, if the property costs 250,000, you have 50,000 saved up for a deposit, and you need a 200,000 mortgage, the loan-to-value ratio would be 80/20 — since the loan you require is 80% of the property’s value.
Most lenders will loan up to 75% of the property’s value. Many will even go to 90% or 95%, and sometimes even 100%, but you’ll pay a lot for this and special rules will apply.
The amount you can borrow will vary between lenders but usually it is three and a half times your annual earnings. So if your combined earnings are 60,000, the maximum size mortgage you can get would be around 210,000.
2. Identify how much you want to borrow
The first thing that you should do before looking for a house is analyse your budget. Write down all your incomings and outgoings, and try to work out how much you can reasonably afford to set aside to pay off a new mortgage. This will allow you, usually with the help of a mortgage expert, to work out the maximum price you can afford to pay for a new property. You could also try using the online budget and mortgage calculators available through the Money Advice Service.
In working out your budget, you need to be completely honest with yourself about how much you earn and spend each month. Most people tend to underestimate their outgoings and overestimate their incomings. Also remember that in the first year or so after you move in you’ll probably need to pay for repairs on the property — therefore, don’t forget to set aside some money to build up a contingency fund.
Remember also to budget for the costs associated with buying a house, such as mortgage adviser and arrangement fees, estate agents’ fees, stamp duty land tax, legal fees, and the cost of the mortgage valuation report and survey.
If you think it’ll be too hard to get a mortgage using just your own income, you could ask your family or friends to act as guarantors. This means that their income will be taken into account when deciding how much you can borrow. Acting as a guarantor is a massive commitment, however, as they will be responsible for paying the mortgage if you default — so do not ask lightly!
You may also want to consider buying a place with friends. Some lenders will take the incomes of up to four people into account when deciding how big a mortgage to give. If you buy with friends, however, make sure you get a legal document drawn up so that everyone knows exactly where they stand.
3. Improve your credit score and clear debts
Having a good credit score is essential in buying property. There are a number of simple steps you can take to boost your score, such as registering on the electoral roll and setting up direct debit to ensure all your bills are paid on time. You should also try to clear any debt you’ve built up on credit or store cards.
4. Decide how much you can afford for a deposit
Very few lenders offer 100% mortgages nowadays, so at an absolute minimum you will need a cash deposit of between 5 to 10% of the property’s value. The bigger the deposit the better since it will reduce the total amount you need to borrow and you’ll get a better interest rate. If you’re struggling to fund a deposit, your family or friends may be able to help. As above, however, this is a major commitment so do not take it for granted that they will help.
5. Research the market and identify your preferred lender
Don’t just go with the first mortgage you see. Deals vary significantly among lenders. Some target buyers with big deposits, others want you to commit to a long term fixed rate. Research the market and shop around.
6. Get your paperwork in order
Every lender will want to see paperwork attesting to your employment history, salary, identity, and a record of prior mortgage or rental payments. They will also examine your credit report and evaluate your other debts.
Many lenders / mortgage advisers offer mortgage approvals, or agreements in principle, stipulating the amount they’re provisionally prepared to lend. You can then use this approval to make an informed decision about whether to make an offer on for a property.
8. Choose a solicitor or licensed conveyancer
After you’ve found a property you want to buy and the seller has provisionally accepted your offer, you should contact a solicitor or licensed conveyancer as a matter of priority to begin the legal process of buying your house. Some lenders have preferred solicitors, or you may be able to get a personal recommendation. You can also search in our Solicitor Directory.
9. Complete a full mortgage application and pay for mortgage valuation report
If the seller accepts your offer, you will need to complete a full mortgage application. The lender will want to see the paperwork identified above and may ask you to pay an application fee.
Your lender will also ask you to pay for a mortgage valuation report to confirm that the property is worth the amount that you have asked to borrow. The cost of a basic mortgage valuation costs about 100-300, depending on the size and cost of the property.
10. Accept formal mortgage offer
If your application is accepted, the lender will issue a formal mortgage offer. The lender will probably send one copy to you and another to your solicitor. After you or your solicitor return the offer documents, the lender is committed to providing the loan.
11. Obtain building insurance
In accepting the offer, your lender will probably require to take out building insurance on the property.
12. Schedule exchange and completion
At exchange, the purchase and sale of the property become legally binding. Your solicitor will conduct a short telephone conversation with the other party’s solicitor, pay a non-refundable deposit, and commit to paying the rest of the purchase price on the completion date.
On completion, the lender will finally release the mortgage funds to pay the seller of the property, and your get to move into your new home!