Where Does The Word “Mortgage” Originate?
The word “mortgage” actually means “death pledge”!
Apparently it originates from an old language called Law French and refers to the pledge (your mortgage) ending (dying) when either the obligation is fulfilled (you’ve paid up your mortgage in full) or the property is taken through foreclosure (you’ve not kept up with repayments and your home has been repossessed!).
So What Exactly is a Mortgage?
A mortgage, quite simply put, is a loan. The loan is secured against the borrower’s property, meaning that if the borrower defaults (fails to make) on the mortgage repayments, the lender can legally take possession and sell the secured property (“foreclosure”) to pay off the loan.
Loan To Value (LTV) and Mortgage Deposit
The LTV of a mortgage is the ratio of the amount you want to loan against the value of the property you are purchasing.
If a mortgage has a 90% LTV you will be required to pay 10% of the value of the property you are purchasing as a deposit and the remaining 90% will be the amount of the mortgage. For example, on a property worth £250,000 with a 75% LTV mortgage, you will be required to pay a deposit of £62,500 (25% of £250,000) and the mortgaged amount will be £187,500 (75% of £250,000).
Bank of England (BoE) Base Rate
You’ll hear this term crop up every once in a while. The BoE is the UK’s central bank. When the BoE lends money to commercial banks (who offer you a mortgage), the commercial banks must pay interest and the amount of interest they pay is determined by the BoE base rate.
The base rate can fluctuate throughout the year based on inflation forecasts. If the BoE expect inflation to rise (because lots of people are splashing the cash, and as a result the cost of services are increasing) they will increase the base rate so that less people splash the cash, and the cost of services reduces.
Conversely if the BoE expects deflation (because less people are splashing the cash, and as a result the cost of services is reducing) they will decrease the base rate so that more people splash the cash, and the cost of services increases.
It’s a bit of a balancing act. Anyway, what has the BoE base rate got to do with mortgages?
Tracker/Variable Rate Mortgage or Fixed Rate Mortgage
With a tracker/variable rate mortgage, the interest you pay on the mortgage changes in line with the BoE base rate. So if the BoE base rate increases, so will the interest rate on your mortgage and so will your monthly repayments! However if the BoE base rate decreases, the interest rate on your mortgage will also decrease and hence your monthly repayments will reduce too! It’s a bit of a gamble.
With a fixed rate mortgage, the interest you pay on the mortgage loan will remain static for a specific period regardless of any fluctuations in the BoE base rate. The beauty of this is that you know exactly how much your monthly mortgage repayments will be and if the BoE base rate increases, the interest on your mortgage and your repayments will remain the same. The ugly part of this is that if the BoE base rate reduces, your interest rate will still remain the same and you won’t reap the benefits of reduced repayments like you would with the tracker/variable rate mortgage!
Repayment Mortgage or Interest Only Mortgage
As discussed, if you take out a mortgage you will have interest to pay on it over the term of the mortgage. After all the lenders need to make a profit! The mortgage term is the duration of time the mortgage loan needs to be paid back in full.
Let’s do a quick example to illustrate the difference between a repayment mortgage and an interest only mortgage:
Assuming you borrowed £100,000 at an interest rate of 3.92% over a 25 year mortgage term, you would have to pay back the debt capital (£100,000) plus the interest accrued over that 25 years (£57,029) to bring the total amount of borrowing to £157,029.
Using this example with a repayment mortgage, your monthly repayments will pay off part of the debt capital as well as some of the interest on the loan. So over time the debt capital will reduce and you will get closer and closer to paying off your mortgage!
Contrast this with an interest only mortgage where your monthly repayments will only pay off the interest on the loan and not the debt capital. Hence the repayments will be lower, but you will NOT reduce the debt capital. And in that sense you will be no closer to paying off your mortgage.
You would generally opt for an interest only mortgage if you wanted your repayments to be lower and more manageable. It is worth noting that some mortgage lenders allow you to make overpayments on interest only mortgages, so that you can also pay off some of the debt capital.
Mortgage Overpayments
Overpayments on your mortgage enable you to pay off the debt capital faster – this can apply to both repayment mortgages and interest only mortgages. You can usually overpay a maximum of 10% of the debt capital per year which in our example would equate to £10,000.
Depending upon interest rates at the time, it often makes better financial sense to pay off more of your mortgage debt capital rather than save money in a bank account to accrue interest! However if you pay off too much (usually more than the 10%) you could incur an early repayment charge!
Incentive Period and Early Repayment Charges (ERC)
Every mortgage deal that you see has an incentive period where the interest rate is at its lowest – the incentive period is usually 2, 3, 5 or 10 years. If you take out a mortgage with one provider and then see a different provider offering a lower rate of interest, swapping providers during your incentive period may incur an ERC which could potentially cost thousands of pounds! It’s important that you check if early repayment charges apply.
When the incentive period comes to an end you can switch mortgage deals without ever incurring an early repayment charge. One of the biggest pieces of advice to remember is to be very vigilant when your incentive period expires. After this date the interest on your mortgage will increase to what is called a standard variable rate (SVR), and as a result so will your repayments!
Overall Cost for Comparison (APR – Annual Percentage Rate)
Every mortgage deal has an APR which is a calculation of the annual percentage of interest over the term of your mortgage. Note that whilst this is intended to make comparing mortgage deals easier, it’s actually advisable to ignore APR since realistically you won’t be on the same mortgage deal for the term of your mortgage! As aforementioned you will be switching your mortgage deal after your incentive period has expired!
Additional Mortgage Fees
Mortgages often incur additional fees. An arrangement fee is common and depending upon the type of mortgage you choose it can either be free or up to £2,000. This fee doesn’t usually need to be paid up front and can instead be added onto your mortgage to pay off in smaller chunks over the term of your mortgage.
A valuation fee may also apply because the mortgage lender needs to ensure that you’re not purchasing a garden shed for £200,000! Remember that the loan is secured against the borrower’s property, and if the property gets repossessed the value needs to be enough to pay off the mortgage. The fee for a property valuation typically ranges from £100 to £400 depending upon the size of the property.
Mortgage in Principle/Agreement in Principle/Decision in Principle
This interchangeable term refers to a mortgage lender agreeing ‘in principle’ to lend you a certain amount of money based on your credit score and other factors. These agreements usually expire between 60 and 90 days after it has been issued, after which time you would need to re-apply.
It’s useful to obtain a mortgage in principle prior to making an offer on a property since it proves that you financially ready to buy. At least you know that if your application for a mortgage in principle is rejected, there’s not much point in making an offer on a property! If your application is rejected it is worth trying with other lenders too, or indeed a mortgage broker, although bear in mind that each lender will perform a credit check and too many of these may adversely affect your credit score.
The key word in the statement is ‘in principle’. A mortgage in principle is by no means a guarantee. If you want to apply for a mortgage based on your mortgage in principle, the mortgage lender will dig a bit deeper into your circumstances and your finances. After such due diligence, the terms of your mortgage offer may change slightly depending upon the findings.
