Energility Energy & Utilities

Mortgages Explained

A Simple Guide to Understanding How Mortgages Work

For most people, buying a home is the biggest financial commitment they will ever make.

However, mortgages can seem complicated.

There are different interest rates, repayment methods, deposit sizes, fixed periods, fees and affordability checks.

At first, it can feel like there is a lot to understand.

Fortunately, the basic idea is quite simple.

A mortgage is a loan used to buy a property.

You borrow money from a lender.

Then, you repay it over an agreed period.

Usually, you also pay interest.

This guide explains the main parts of a mortgage in plain English.

What Is a Mortgage?

A mortgage is a loan that is secured against a property.

This means the property is used as security for the loan.

For example, imagine you want to buy a home for:

£200,000

You have a deposit of:

£20,000

So, you need to borrow:

£180,000

The £180,000 is your mortgage.

You then repay that money, plus interest, over an agreed period.

This might be:

  • 20 years
  • 25 years
  • 30 years
  • 35 years

or sometimes longer.

How Does a Mortgage Work?

A mortgage payment normally includes two parts:

The money you borrowed

and:

The interest charged by the lender

With a repayment mortgage, each monthly payment gradually reduces the amount you owe.

At the beginning, however, a larger part of the payment may go towards interest.

Over time, more of your payment goes towards reducing the loan itself.

So, the mortgage balance gradually falls.

The Deposit

The deposit is the money you contribute towards the cost of the property.

For example:

Property price: £200,000

Your deposit: £20,000

Mortgage needed: £180,000

In this example, your deposit is 10% of the property price.

The mortgage covers the remaining 90%.

Generally, a larger deposit means you need to borrow less.

As a result, your monthly payments may be lower.

You may also have access to a wider range of mortgage deals.

However, it is important not to use every penny you have for the deposit.

You may also need money for:

  • Legal fees
  • Surveys
  • Moving costs
  • Mortgage fees
  • Insurance
  • Repairs
  • Furniture and equipment

Therefore, leave yourself a sensible financial buffer where possible.

What Is Loan-to-Value?

Loan-to-value is usually shortened to:

LTV

It shows how much you are borrowing compared with the value of the property.

For example:

Property value: £200,000

Mortgage: £180,000

To work out the LTV:

£180,000 ÷ £200,000 × 100 = 90%

So, the mortgage has a:

90% LTV

The remaining 10% is your deposit.

Why Does LTV Matter?

Generally, the lower your LTV, the lower the risk may appear to the lender.

For example:

  • 95% LTV = 5% deposit
  • 90% LTV = 10% deposit
  • 80% LTV = 20% deposit
  • 75% LTV = 25% deposit
  • 60% LTV = 40% deposit

Mortgage deals are often grouped into LTV bands.

Therefore, even increasing your deposit slightly may sometimes give you access to different rates.

However, you should compare the whole deal.

A lower interest rate does not always mean the mortgage is automatically cheaper once fees are included.

Repayment Mortgages

Most residential mortgages are repayment mortgages.

With this type of mortgage, your monthly payment pays:

Interest

and:

Part of the loan

As long as you make all the required payments, the mortgage should normally be fully repaid by the end of the term.

For example, imagine you borrow:

£180,000

Over 25 years, your payments gradually reduce the balance.

Eventually, the amount you owe reaches:

£0

The property is then no longer subject to the mortgage loan.

Interest-Only Mortgages

With an interest-only mortgage, your regular payments normally cover the interest.

However, they do not normally reduce the original loan.

For example, you may borrow:

£180,000

During the mortgage term, you pay the interest.

However, you may still owe:

£180,000

at the end.

Therefore, you need a clear and credible way to repay the original loan.

Interest-only mortgages are not suitable for everyone.

They can also be more difficult to obtain for a residential home.

So, it is important to understand exactly how the loan will be repaid before choosing this type of mortgage.

Fixed-Rate Mortgages

A fixed-rate mortgage keeps the interest rate the same for an agreed period.

For example:

  • Two years
  • Three years
  • Five years
  • Ten years

This can make budgeting easier.

You know what your interest rate will be during the fixed period.

However, your monthly payment can still change in some situations.

For example, if the mortgage is on a variable payment arrangement or other costs change.

Therefore, always check the exact terms.

When the fixed period ends, your mortgage will normally move to another rate unless you arrange a new deal.

Variable-Rate Mortgages

A variable-rate mortgage has an interest rate that can change.

This means your monthly payments may:

Go up

or:

Go down

There are different types of variable mortgage.

These can include tracker mortgages and lender-set variable rates.

The exact way the rate changes depends on the mortgage.

Therefore, check the terms carefully before choosing.

A lower starting rate can be attractive.

However, you should also consider what may happen if interest rates rise.

Tracker Mortgages

A tracker mortgage usually follows an external rate.

For example, it may track the Bank of England base rate plus or minus an agreed percentage.

A simple example might be:

Base rate + 1%

If the tracked rate changes, your mortgage rate may also change.

Therefore, your monthly payment can rise or fall.

Before choosing a tracker, make sure you could still afford the payments if interest rates increase.

Standard Variable Rate

Many mortgages move to the lender’s Standard Variable Rate, often shortened to:

SVR

when an introductory or fixed period ends.

The lender can change this rate.

Therefore, it may rise or fall.

The SVR may also be higher than the rate you were previously paying.

So, before your current deal ends, it can be sensible to review your options.

How Long Should Your Mortgage Term Be?

The mortgage term is the total time you have to repay the loan.

For example:

25 years

or:

35 years

A longer term usually reduces the monthly payment.

However, there is an important trade-off.

You may pay interest for longer.

Therefore, the total amount of interest paid can be higher.

A Simple Example

Imagine you borrow the same amount of money at the same interest rate.

With a longer mortgage term:

Monthly payments may be lower

However:

Total interest may be higher

With a shorter mortgage term:

Monthly payments may be higher

However:

Total interest may be lower

Therefore, the best term is not simply the shortest or longest one.

Instead, it should provide an affordable payment while fitting your wider financial plans.

How Much Can You Borrow?

Lenders look at several things before deciding how much they are willing to lend.

This can include:

  • Your income
  • Your regular spending
  • Existing debts
  • Credit commitments
  • Household costs
  • Number of dependants
  • Employment situation
  • Deposit
  • Credit history

Lenders will also consider whether you could continue making payments if circumstances or interest rates change.

Therefore, the amount you can borrow is not based on income alone.

Mortgage Affordability

Mortgage affordability is about more than whether you can afford the payment today.

A lender will normally look at your wider financial situation.

For example, they may consider:

Income

Regular commitments

Loans and credit

Household spending

and:

Possible future changes

This is designed to reduce the risk of someone taking on a mortgage they may struggle to repay.

However, the amount a lender is willing to offer may not be the amount you personally feel comfortable borrowing.

Therefore, set your own budget too.

Your Monthly Mortgage Payment

Your monthly payment depends on several things.

These include:

  • How much you borrow
  • The interest rate
  • The mortgage term
  • The repayment method

For example, borrowing more usually means higher payments.

Likewise, a higher interest rate can increase the monthly cost.

A longer term, however, may reduce the monthly payment.

Therefore, all four factors work together.

An Example Mortgage Calculation

Imagine:

Mortgage: £180,000

Interest rate: 5%

Term: 25 years

The exact monthly payment would depend on the mortgage terms and repayment method.

However, the key point is this:

A change in either the:

  • Interest rate
  • Mortgage term
  • Amount borrowed

can change your monthly payment.

Therefore, it is useful to test different scenarios before applying.

For example:

What happens if rates rise by 1%?

or:

What happens if I choose a 30-year term instead?

This can help you understand your options.

Mortgage Interest

Interest is the cost of borrowing the money.

For example, if you borrow:

£200,000

you will normally repay more than £200,000 over the life of the mortgage.

The difference is mainly made up of interest, although fees may also apply.

The amount of interest you pay can be affected by:

  • Your interest rate
  • The amount borrowed
  • The mortgage term
  • How quickly you repay the loan

Therefore, even a small difference in interest rate can matter over time.

Mortgage Fees

Some mortgages come with fees.

These can include:

  • Product fees
  • Arrangement fees
  • Booking fees
  • Valuation fees
  • Legal fees

The fees can sometimes be paid upfront.

Alternatively, some may be added to the mortgage.

However, adding a fee to the mortgage means you may also pay interest on it.

Therefore, compare the total cost rather than looking only at the headline interest rate.

Mortgage Valuations

A lender may arrange a valuation of the property.

This is mainly for the lender.

It helps them decide whether the property provides suitable security for the loan.

However, a mortgage valuation is not the same as a full property survey.

It may not identify every defect or problem.

Therefore, you may want to consider whether you need a more detailed survey.

This can be particularly important with older properties or homes that may need work.

Mortgage Overpayments

Some mortgages allow you to make overpayments.

This means paying more than your required monthly amount.

Overpayments can reduce the mortgage balance faster.

As a result, you may:

  • Pay less interest overall
  • Reduce the mortgage term
  • Build more equity

However, some mortgages limit how much you can overpay.

There may also be charges if you exceed the allowed amount.

Therefore, always check the terms first.

What Is Equity?

Equity is the part of the property that you own outright.

For example:

Property value: £250,000

Mortgage remaining: £150,000

Your equity is:

£100,000

Equity can increase when:

  • You repay your mortgage
  • The property rises in value

However, property prices can also fall.

Therefore, equity can decrease if the value of your home falls.

Remortgaging

Remortgaging means replacing your existing mortgage with a new one.

This may be with:

Your current lender

or:

A different lender

People remortgage for several reasons.

For example:

  • Their current deal is ending
  • They want a different interest rate
  • They want to change the mortgage term
  • They want to borrow more
  • Their financial situation has changed

However, remortgaging is not always the best option.

There may be fees or early repayment charges.

Therefore, compare the full cost before making a decision.

Early Repayment Charges

Some mortgages have an Early Repayment Charge, often called an:

ERC

This is a charge that may apply if you repay or leave the mortgage early.

For example, an ERC may apply if you:

  • Remortgage during a fixed period
  • Move to another lender early
  • Repay a large amount above the allowed limit

The charge can sometimes be significant.

Therefore, check before making major changes to your mortgage.

Moving Home With a Mortgage

If you move home, there are several possibilities.

You may:

  • Take out a new mortgage
  • Move your existing mortgage to the new property, if it is portable
  • Borrow additional money
  • Repay the existing mortgage and arrange another one

The best option will depend on the mortgage and your circumstances.

Therefore, check the costs before making decisions.

In particular, consider whether an early repayment charge may apply.

Mortgage Porting

Some mortgages are described as portable.

This means you may be able to take the mortgage product with you when you move.

However, the mortgage does not simply move automatically.

The lender will normally reassess the situation.

You may also need additional borrowing if the new property costs more.

Therefore, portability can be useful.

However, it does not guarantee that you can simply transfer the mortgage without further checks.

Buying Your First Home

Buying your first home can involve several steps.

Usually, you will need to:

Save a deposit

Then:

Check what you may be able to borrow

Next:

Find a suitable property

After that:

Arrange a mortgage

Then:

Appoint a solicitor or conveyancer

Finally:

Complete the purchase

There may be other steps in between.

However, understanding the basic process can make it feel more manageable.

Buying a Home With Someone Else

If you buy with another person, you may combine your income.

This could increase the amount you are able to borrow.

However, you also share responsibility for the mortgage.

Therefore, it is important to think about:

  • How payments will be shared
  • What happens if one person cannot pay
  • What happens if someone wants to sell
  • How the property will be owned

It can be useful to get professional legal and financial advice before making a joint commitment.

Your Credit History

Lenders will usually look at your credit history.

This can help them understand how you have managed credit in the past.

Before applying for a mortgage, it can be sensible to check your credit information for errors.

For example, make sure:

  • Your personal details are correct
  • Old accounts are properly recorded
  • Your address history is accurate
  • You understand any missed payments shown

If you find incorrect information, contact the organisation responsible for the record.

Mortgage in Principle

A Mortgage in Principle gives you an indication of how much a lender may be willing to lend.

It can be useful when you are looking at properties.

However, it is not normally a final mortgage offer.

The lender will still need to carry out further checks.

These may include checking:

  • Your income
  • Your spending
  • Your credit history
  • The property

Therefore, do not assume that a Mortgage in Principle guarantees the final mortgage.

What Happens After You Apply?

Once you make a full mortgage application, the lender will assess your circumstances.

It may:

  • Check your documents
  • Confirm your income
  • Review your spending
  • Carry out credit checks
  • Arrange a property valuation

If the lender is satisfied, it may make a formal mortgage offer.

Your solicitor or conveyancer will then continue the legal work involved in buying the property.

Mortgage Protection and Insurance

A mortgage is a major financial commitment.

Therefore, it can be sensible to think about what would happen if your circumstances changed.

For example, people may consider:

  • Life insurance
  • Income protection
  • Critical illness cover
  • Buildings insurance

However, different products suit different people.

Some insurance may also be required as part of your mortgage arrangements, depending on the property and lender.

So, understand what is required and what is optional.

What Happens If You Cannot Pay Your Mortgage?

If you are struggling to make your mortgage payments, contact your lender as soon as possible.

Do not simply ignore the problem.

The earlier you speak to the lender, the more options may be available.

You may also be able to get free, independent debt or money guidance.

Most importantly, act early.

Mortgage arrears can become more difficult to deal with if they are allowed to build up.

Your Home May Be Repossessed

A mortgage is secured against your property.

Therefore, if you do not keep up with repayments, the lender may eventually take action to recover the debt.

In the most serious cases, this could lead to your home being repossessed.

This is why it is important to borrow responsibly.

Before taking out a mortgage, make sure you understand the payments and the risks.

Choosing the Right Mortgage

There is no single mortgage that is best for everyone.

The right choice depends on your circumstances.

For example, you may need to consider:

  • Monthly affordability
  • Deposit size
  • Mortgage term
  • Interest rate
  • Fixed or variable rate
  • Fees
  • Flexibility
  • Overpayment options
  • Early repayment charges
  • Your future plans

Therefore, take time to compare the full details.

A mortgage is a long-term commitment.

So, a decision based only on the lowest headline rate may not always give the best result.

A Simple Mortgage Checklist

Before applying, ask yourself:

  • How much deposit do I have?
  • How much do I need to borrow?
  • What is the property’s LTV?
  • What monthly payment can I comfortably afford?
  • Could I still afford it if rates increased?
  • How long do I want the mortgage term to be?
  • Do I prefer a fixed or variable rate?
  • What fees are involved?
  • Can I make overpayments?
  • Are there early repayment charges?
  • What happens when the initial deal ends?
  • How much will the mortgage cost overall?
  • Do I have money left for legal fees, moving and repairs?

Take your time with each question.

The aim is not simply to get a mortgage.

It is to get one that you can afford and manage comfortably.

Compare Mortgages With Energility

Energility is currently developing its future mortgage comparison services.

Our aim is to make it easier to compare mortgage options and understand how different deals work.

The comparison service is planned to launch over the coming months.

In the meantime, you can use our free guides to learn more about:

  • How mortgages work
  • Mortgage interest rates
  • Fixed and variable rates
  • Deposits and LTV
  • Mortgage affordability
  • Remortgaging
  • Buying your first home
  • Mortgage costs and fees

We believe comparison works best when it is combined with clear information.

After all, choosing a mortgage is easier when you understand what you are comparing.

Quick Summary

A mortgage is a loan used to buy a property.

You normally contribute a deposit.

Then, you borrow the rest.

Your monthly payment depends on:

  • The amount borrowed
  • The interest rate
  • The mortgage term
  • The type of mortgage

You may choose between different mortgage types, including fixed and variable rates.

You should also compare:

The interest rate

The fees

The total cost

and:

The flexibility of the mortgage

Most importantly, choose a mortgage based on what you can comfortably afford.

Do not borrow more simply because a lender is willing to offer it.

A mortgage should support your plans for the future.

It should not leave you struggling every month.

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