You’ve found your dream home, but now what? Unless you are one of the 1% that can afford to purchase a house outright, you will need to secure a loan. Financing your home can be complicated and is not without risk, but as long as you understand the underlying fundamentals, the process can be hassle-free.
At the most basic level, a mortgage is a loan that is taken out to fund the purchase of property or land. The lender is normally a bank or a financial institution that the borrower pays back through a monthly schedule. The payback amount and schedule vary depending on the specific type of mortgage that is secured — either repayment or interest only.
Mortgages are simply in theory, but complicated in practice. The huge competition between building societies and banks has resulted in a range of mortgages being offered that can confuse even the most knowledgeable consumer. Fortunately, nearly every mortgage is a form of either a repayment or an interest only mortgage.
In a repayment mortgage, the homeowner makes a monthly payment that repays both the interest and the principal (the original amount borrowed). Repayment mortgages are considered to be the least risky type of mortgage, and the least complicated as well.
Interest only mortgage
In an interest only mortgage, the homeowner only makes monthly interest payments. The borrower then pays back the principal when the term of the mortgage ends. This type of mortgage has grown in popularity in recent years among homeowners. Since the homeowner can delay the repayment of the principal, it is a cheaper alternative to repayment mortgages.
Many buy-to-let investors use this type of mortgage, as well as those with individual savings accounts (ISA). The cheaper cost does not come without risk, however, since you will have to be able to pay back a large sum of capital at the end of the mortgage term.
Mortgages, like any other debt, require you to pay interest. Even though recent economic events have highlighted the risks of variable rate mortgages, it is important for you to understand the full-range of options available:
A fixed rate of interest means that the monthly interest rate repayments are the same during the agreed-upon period, which is ordinarily two to five years. The rate is determined through the borrower’s mortgage contract, and will depend on the borrower’s financial history, as well as the principal amount.
Fixed rate mortgages are suitable for homeowners who are on a tight budget, or for those who believe interest rates are going to rise. You should always be aware of the amount of time you are required to stay with the lender before being allowed to switch without penalty. Often, borrowers get trapped into fixed rate mortgages and are unable to switch to a better mortgage when rates fall.
A variable rate of interest means that the monthly interest rate repayments will fluctuate based on an agreed-upon base rate, with the most common rate being prevailing interest rates. There are numerous types of variable rate mortgages, each with their own pros and cons.
With a capped interest rate, your monthly payments are linked to a base rate, but are also capped at a threshold above which they cannot rise. This provides security in knowing your maximum monthly mortgage payment, but also allows you to benefit from a decrease in interest rates.
Discount rate mortgages provide a discount on the lender’s variable rate for an agreed-upon period. When this period ends, you will pay the standard variable rate.
With a tracker rate mortgage, the interest rate is linked to the Bank of England base rate, and is usually set within a percentage or two of the rate. Similar to a fixed rate, the term of the tracking rate is usually for two or five years, however, lifetime rates do exist.
If you have missed any payments on your mortgage, you are in mortgage arrears. If you do not take immediate action, your mortgage lender may take legal action to get you evicted from your home. Learn more below:
Even if the mortgage lender is unwilling to reduce your monthly mortgage payment, you will still have to come up with a plan to pay back the arrears. Otherwise, your mortgage lender will almost certainly take steps to repossess your home.
Once the budget has been drawn out, you should contact your mortgage lender as soon as possible and make them an offer on the arrears repayment. The offer should be sent by letter and be as comprehensive as possible. Include a copy of your budget, as well as any pertinent financial statements with your letter so that your lender can understand how you arrived at your conclusions. Even if your lender does not accept the offer, you should still make regular payments. This may help your case if you are taken to court by the mortgage lender.
Provided your lender agrees to it, it is much better for you to personally sell the property than the lender. Repossessed properties have a negative stigma attached to them, which often leads to them being sold for substantially less. Additionally, mortgage lenders sell repossessed homes at auctions, which generally result in lower sale values.
If you are struggling with your mortgage payments, there is a chance that government programs can help. If you are are currently receiving one of the following benefits, you are eligible for Support for Mortgage Interest (SMI):
If you are eligible for SMI, you will receive help paying the interest on your mortgage for up to £200,000 (£100,000 if you are receiving pension credit). The benefits are paid directly to your lender 13 weeks after you’ve claimed the benefit. The waiting period is waived if you are receiving pension credit.
Another government program, the Mortgage Rescue Scheme, is only available in England. To be eligible for assistance through the Mortgage Rescue Scheme, you must meet the following criteria:
The Mortgage Rescue Scheme provides two types of financial assistance. They both require you to use a Registered Social Landlord (RSL), which is a non-profit housing entity that is approved and regulated by the government. The two types are:
An equity loan is an interest-only loan that helps pay off your mortgage. It requires you to have 40% or less equity in your property. The loan is for between 25% and 75% of your mortgage, and can be taken out for up to 25 years.
Government mortgage to rent
In a government mortgage to rent, the RSL buys your home for 90% of its current market value. This allows you to remain in your home and pay rent to the RSL, which will be 20% less than the prevailing market rate for the local area your home is situated in.