Understanding mortgages: the basics

Understanding mortgages – the basics

The information in this guide was last updated on 26/02/2014

Becoming a homeowner for the first time can be both exciting and daunting. This quick guide takes you through the home buying process, from finding your first home to securing a mortgage from your lender.

What is a mortgage?

Very few first time buyers will buy a property outright. Most people rely on a mortgage, to help them buy a home, which is a loan secured against a property. Having a mortgage means that:

  • you borrow money to buy a property
  • you repay your mortgage over an agreed period of time depending on your needs and circumstances.

Your home may be repossessed if you do not keep up repayments on your mortgage, which is why it’s very important to choose a manageable repayment schedule.

How to find the best mortgage deal

When you start looking for a mortgage the choice can be bewildering. The main factors that will influence your choice of mortgage are:

  • the amount you need to borrow
  • the deposit you have
  • the amount you can afford in monthly repayments.

Online mortgage calculators and price comparison sites can be a good way to get a feel for types of mortgages are available, what the current best mortgage rates are, and how much you’re likely to be able to borrow.

It can also be worth contacting an independent mortgage broker. You often won’t pay anything for their service up front – instead, they’ll be paid a fee if you take out a mortgage through them, either by the lender or by you.

Brokers have comprehensive information on the mortgages currently on the market – often including lenders that don’t put their products on price comparison sites.

Download our First Time Buyers' Guide

Our independent First Time Buyers' Guide provides a breakdown of everything you need to know when buying your first home.

What are the different types of mortgage product?

Different mortgages come with very different repayment options and interest rates. Below is a section of some common types.

  • Fixed rate mortgages mean you agree on a rate of interest that stays the same for a set period of time.
  • Variable rate mortgages mean your payments go up or down depending on the interest rates set by your lender.
  • Tracker mortgages mean your payments can go up or down since they’re linked to an interest rate, often set by the Bank of England.
  • Capped rate mortgages are a type of variable rate mortgage, which have a cap or ceiling on the amount that you will have to pay. Your payments may go up or down under that amount, as interest rates increase or decrease, but you wouldn't have to pay more even if the interest rates rise higher.
  • Collared mortgages are usually found in combination with a capped or tracker mortgage – it means there's a set limit on how low interest rates may go (the 'collar'), so your payments would never fall lower than a certain level.
  • Cashback mortgages give you an extra lump sum of money, often at the beginning of your mortgage.
  • Offset mortgages allow you to cut down on the interest you pay on your mortgage by sacrificing interest earned on your savings (held with the same lender in a savings account).

Ways to repay your mortgage

There are three ways you can repay your lender, depending on what they offer and your financial circumstances:

  • Repayment (capital and interest)

This is the most common option. Your regular repayment is made up of some of the amount borrowed plus interest every month. It means your mortgage will be repaid in full by the end of the term providing all payments are maintained in full and on time.

  • Interest-only

This means each month you only pay the interest on what you've borrowed, which usually means lower monthly repayments. However, at the end of the agreed ‘mortgage term’ you still owe the whole amount borrowed and you have to find a way to pay that back. You'll need to be paying into another investment to accumulate the money needed to repay the mortgage at the end of the term, such as an endowment policy, ISA, or pension, or have an alternative repayment plan in place, and be confident that you have in place the means to repay the full loan mount at the end of the term. Many lenders now restrict the size of the loan you can have on an interest only mortgage to a certain percentage of the property value (e.g. a maximum loan of 50% of the property value).

  • Part and part mortgage

This is an option that lets you repay part interest-only and part repayment each month.

Don't forget insurance

It's usually a condition of your mortgage to have insurance to protect your home - often referred to as home insurance, it's usually split into buildings and content insurance:

  • Buildings insurance: this covers you financially for any damage to your building (e.g. from fire, flood or wind). Make sure that you look at the level of cover as well as the cost of the policy. Most mortgage lenders will insist on seeing this in place before completion.
  • Contents insurance: this is often overlooked because it's another expense, but just think what it would cost if you had to replace everything in your home because of flood damage, fire or theft - furniture and furnishings, TV and audio, all electrical goods and appliances, and clothing and jewellery.

Mortgage related protection

Now you have your home covered, what about you?  You may want to think about how you'd manage to pay your mortgage if you were unable to work because of illness or injury, or how your loved ones would cope if you died. 

There are several kinds of insurance that you could look at to safeguard your home and your ability to pay for it: 

  • Critical illness: this can give you a lump sum if you suffer one of the critical illnesses the policy covers. It’s a way of securing some financial help at a time when you might really need it.    
  • Life assurance: this can pay a lump sum to your loved ones if you die (or with some policies if you’re diagnosed with a terminal illness).
  • Income protection: this can give you a regular monthly income if you are off work for a prolonged period because of an accident or illness. 

You can match the cover provided by all these policies to your mortgage to give you the ‘mortgage protection’ you need. It's important you seek financial advice to help you achieve this.  

Your options

How much can you afford?

How to apply for a mortgage

Finding a property