Mortgages: How they work and which one is right for you
In short, a mortgage is a loan given by a provider, in order to buy a property. In this blog post, we’ll look at how mortgages work and steps you can take towards getting your first mortgage. We’ll also look at the Shared Ownership scheme, how that works and some pros and cons to help you decide if it’s something that would work for you.
How a mortgage works
If you had to save up the entire price of a house or flat before you bought it then most likely you’d never be able to afford it. However, by borrowing some money from a lender you only need to have a fraction of the total value up front. (This is called the deposit).
The amount you are able to put down as a deposit on the property impacts the size of the mortgage that you can take out. The higher the deposit, the smaller the mortgage you need!
Let’s take a house of £200,000 for example. If you are able to put down a deposit of 10% (i.e. £20,000), the size of your mortgage would be £180,000. The larger the deposit you are able to save, the smaller the amount you need to borrow and the better mortgage rates you’ll qualify for.
The relationship between the amount borrowed and size of the deposit is referred to as ‘LTV’ – or Loan To Value. The LTV shows the amount you are borrowing compared to the value of the house as a whole.
Your salary also impacts the size of the mortgage that you can get. Usually, the maximum mortgage that you can borrow is around 4.5x the size of your salary.
How do I get a mortgage?
- Step one: The first step to buying a property is to have a deposit. This means you have saved up a proportion of the value of the property that you are wanting to purchase. The higher the proportion, the better mortgage rates you are likely to get! Mortgages with 5% deposits are relatively hard to get, where 15% would get you a great deal, and 25% would give you the best mortgage rates available.
- Step two: You’ll also need to have a good credit. Your credit score is a reflection of how reliably you have repaid debts in the past and therefore how safe it would be for someone to lend you money to buy a property. A bad credit score might mean that you struggle to get any mortgage at all. The better the credit score, the more likely you are to obtain a mortgage, and one with a great interest rate.
- Step three: An important thing to remember is that, in order to get a mortgage, you also need to have some spare money to cover the additional fees and taxes. For example:
Stamp duty is a tax that accompanies buying any large purchase, such as a house. The cost of stamp duty is related to the price of the house, the more expensive the house, the higher the stamp duty.
There are also additional fees that need to be considered such as solicitors fees and mortgage advisor/financial advisor fees.
Some people assume that all you need to buy a mortgage is a deposit, but these additional fees are really important to bear in mind.
- Step Four: Finally, you need to be able to show that you have a good record of living within your means. Basically, that you can keep up with your current outgoings, and don’t have to use loans to get by. This can be done by showing a few bank statements over the previous months to show that you’re not always in your overdraft, or spending significantly more than you earn.
What is remortgaging?
Remortgaging is when you switch your current mortgage to a new mortgage deal, usually in order to get a better deal and save money. It can also be a good way to release some cash if you have some equity in your house. For example, if you have a current mortgage of £90,000, you could remortgage for £100,000 so you will have £10,000 to spend for any purpose.
You’ll usually want to think about remortgaging at least every 5 years to make sure that you’re always getting the best deal on the market. Since the amount you borrow is often in the hundreds of thousands, even saving 1% on the interest rate will leave you significantly better off.
What is Shared Ownership?
For some people, Shared Ownership is the key to getting on to the housing ladder, but it’s not without drawbacks.
Shared Ownership is one part of the government initiative known as ‘Help to Buy‘ which is designed to help more people buy their first home. Most people are familiar with other parts of the scheme, such as the Help to Buy ISA, but Shared Ownership is another important option to consider.
If you can’t afford the mortgage on 100% of a property, the shared ownership scheme allows you to instead get a mortgage and purchase only part of the property (between 25% and 75%), while you pay rent on the remaining portion. Then, when you can afford to do so, you can purchase the rest so that you own 100% of the property yourself.
For example, supposing that there was a property selling for £400,000 and you had a deposit of £20,000. You would need to get a mortgage for £380,000 to cover the rest which you would be unlikely to get unless your household income was at least £80,000 at a minimum.
Instead, the Shared Ownership scheme could allow you to buy half the property by using your £20,000 deposit and getting a mortgage for £180,000 which is much easier to afford.
When you move in, you would then pay a monthly rent to the owner of the other 50% (usually a housing association). Down the line, you may be able to buy out the remaining 50% and so end up owning your whole property.
To take advantage of this scheme you must have a household income less than £80,000 (or less than £90,000 in London), and either be a first time buyer, unable to afford a new home or an existing shared owner looking to move.
Advantages of Shared Ownership
Shared Ownership allows people to get on the property ladder who otherwise might not be able to do so for a long time, since you need a much smaller deposit.
It’s more stable than renting since you’re not relying on a landlord to renew your contract every year, but more affordable than trying to purchase the full property by yourself.
By owning a share of a property you are investing in an asset that has the potential to grow significantly in value. Even if you decide not to ‘ladder up’ to owning the full property, you may choose to sell your share of the property and so get a great return on investment. Particularly if you consider that the alternative might be that you leave the house deposit in a cash savings account earning almost no interest.
Risks of Shared Ownership
There are potential downsides to consider when looking at whether Shared Ownership is right for you.
You’ll need to get a special Shared Ownership Mortgage which usually have higher rates than a normal mortgage. You’ll also be limited when it comes to remortgaging later which may mean you end up paying much more than someone who purchases the whole property from the beginning.
Although it’s called Shared Ownership, technically you would be a tenant until you own 100%. That means that you don’t necessarily avoid the risks that come with renting – for instance you could be evicted for not paying rent and in rare cases end up losing the full amount you have put into the property.
You may not be able to rent out your property later on without permission. If the housing association refuses permission then you would still be required to pay the mortgage and rent or risk losing your property.
All Shared Ownership properties are leasehold, which means that you aren’t buying the land on which the property is built, just leasing it for a period of time. The owners of the land will usually be responsible for maintaining the building and you may have to pay a service charge which goes towards this. You are responsible for 100% of the service charge, even though you only own a proportion of the property, and it may go up in cost in the future.
If you don’t think the housing association is doing a good job then you may not be able to do anything about it – unlike full leasehold owners.
Purchasing the remaining portion of the property may not necessarily be easy to do. If house prices go up dramatically, the price of the remaining share will reflect that.
Ultimately, whether or not Shared Ownership or a regular Mortgage would be right for you depends on your circumstances and financial goals. If you need someone to talk to about making your money work for you, book a free session with one of our friendly coaches and see how we could help.