We’ve all disappeared down the Zoopla or Rightmove rabbit hole. Whether it’s having a sneaky look inside a neighbour’s home, or contemplating whether you would have to redecorate the £1M house you stumbled across, it’s easy to get carried away looking at houses for sale online. When we’re actively looking for a house to buy, the search price perimeters can easily stretch over our initial “budget” as we are keen to see what is within possible reach. When it comes to the business end of buying a home, it’s important to properly understand how you pay for it.
I just think we’d have to rip everything out and start again.
Firstly, it is possible to buy your home for cash, without any debt (do not fall off your chair). And this is not only reserved for the mega wealthy – plenty of people do it.
If however, you are not in a position to do that, generally the way you purchase a property is with a cash deposit and a mortgage.
A cash deposit generally comes from saving, saving and more saving. It could also come from the sale of a previous property, a bonus at work, an inheritance payment or a gift from family – but generally the majority of us work very hard to pile up money ready to hand over as a cash deposit.
The higher the cash deposit as a proportion of the agreed purchase price, the lower the mortgage you need to take out.
A mortgage is loan that you take out to fund the remainder of the agreed purchase price of a property after the cash deposit. So for example, you find a property for £100K, you save up £10K plus some extra money for bank and legal fees and taxes, and so you need a mortgage for the £90K.
A mortgage is secured against the home, which means if you don’t keep up with payments, the home could eventually be “repossessed” and sold to pay off any monies owed.
Mortgage providers, who generally are banks and building societies (regulated by the FCA), describe their mortgages as “products”. This is actually the simplest way to think of a mortgage, as a product. Each product is different from the next and three of the most important elements of the product to think about are:
1. Term: this is how long the mortgage lasts for. The longer the term, the lower the monthly payment BUT the higher amount of interest you will pay over the term. There are lots of online calculators you can use to see the difference, but it can be over £100k more of interest on a longer term mortgage of 35 years, versus a shorter term mortgage of 15 years.
2. Interest Rate: this is the interest rate you pay on the loan, so the cost of the borrowing.
3. Fixed Rate Period: In the UK, we generally have mortgage products that “fix” the interest rate and the “lock in” period before you can end the mortgage, without there being a penalty fee (usually called an Early Repayment Charge).
For example, a product could be a 3 year fixed rate 2.04% 25 year mortgage. This means you are taking on a loan for 25 years, and for the first 3 years, you have secured a rate of 2.04%. Before the 3 year point, if you wanted to end the product, such as sell the house (where the mortgage is redeemed/paid off by the buyer’s money), you would likely need to pay an Early Repayment Charge of a percentage of the outstanding mortgage amount.
At the 3 year point, your mortgage would revert to a standard variable interest rate, which essentially means you come off the 2.04% and jump to a higher one usually. You would see a jump in your monthly mortgage payment amount. At this point, you are free to shop around for another mortgage without penalty.
What kind of things should I consider when looking to get a new mortgage or re-mortgage?
WHERE TO GET ONE?
You should follow these steps in order:
1. Look online at mortgage comparison sites first: get a feel for what is in the market, look for the key elements we’ve set out above, have a think about which parts are important to you and maybe list a few products on a shortlist. The sites will get a commission if you apply for a mortgage via their links (which is fine, they have done the work sourcing the deals for you), but be aware they may show favouritism towards products they get paid a better commission on.
2. Speak to a mortgage broker – explain the products you’ve found and see if they can offer them or even beat them. Find a broker by recommendation and referral. Ask people you trust that seem to have things sorted financially who they use. Ask the broker if they are qualified, whether they charge a fee and whether they can look at the whole of the lending market for all products. The mortgage broker may get a commission if you source the mortgage through them, but you get the benefit of their advice and support.
3. Speak to your bank – remember they will only offer you their own mortgage products, but sometimes they have favourable rates and terms for existing customers and you can use the shortlist you have collated to compare.
4. Go with the best option that suits your needs. Remember, a lot of people forget that you are shopping around to pick a mortgage provider for the biggest loan you will ever take out, not begging them to lend you money. You need to do checks on them just as they will do you.
You should only take out a mortgage that can you can comfortably afford to pay. Whilst some mortgage providers will offer you 4 times your salary, you need to think more about what you can afford.
Generally, we say that your mortgage monthly payment shouldn’t be higher than 30% of your take home pay. Anything higher will limit your ability to invest and grow wealth later and you have no room to move if you suffer an income reduction or loss.
LENGTH OF TIME IN DEBT
If you’re following the Financielle principles, you will be working towards ultimately being completely debt free. The longer the mortgage term, the further away that debt free date. Yes you can overpay the mortgage to lower this term, but practically the majority of people never do. Generally a 15 or 20 year term is a good length, with a view to still overpaying where you can and trying to pay off the mortgage in half the time.
BEING IN GOOD FINANCIAL SHAPE
Applying for a mortgage involves intense scrutiny of people’s finances. Generally, the mortgage provider isn’t trying to catch you out – believe me they want to lend you money – but they do have FCA guidelines to follow. Top tips for being in good financial shape 3-6 months out from applying for a mortgage are:
– displaying consistent levels of income that meet the requirements for the mortgage you are applying for (lenders generally allow a maximum of 4 times your household income, and this is dependent on your other financial commitments such as debt or children).
– having low/manageable levels of debt and where you have debt, paying it off consistently and on time
– having control over your finances, e.g. not going into your overdraft, bills going out consistently, responsible spending.
Yes, mortgage providers take into account your credit score, but be mindful that a low score due to low credit history (rather than poor credit performance such as missed payments/CCJs) does not prevent you from getting a mortgage – this is an urban myth pushed by financial institutions and credit score companies to get you to take on credit. Read our article here on how to build a credit score without taking on credit.
This is just a little insight into the world of mortgages, but hopefully it helps to explain some of the jargon and give some tactics as to how to go about it. As always, if there’s anything missing that you think would be helpful, please email us.