How Mortgage Work

How Mortgages Work
Whether you’re a first-time buyer of a home, moving to a new home or staying put and remortgaging (changing your mortgage plan, but not your home), this site can help you choose a suitable mortgage. You’ll find everything you need to know: how mortgages work, how you can work out what you can afford, and where you can go to compare mortgages.

Let’s start with the basics:

What is a mortgage?
A mortgage is like any other kind of loan, but specific to buying a home – you borrow money, and you pay it back with interest over a period of time. A mortgage is a loan to buy your home. You borrow money and pay it back with interest over a period of time (the ‘mortgage term’) that you agree with the lender – usually a bank or building society.

Seems like a simple loan, but it has one key difference: The mortgage loan is secured against your home so if for any reason you can’t repay it, the bank or building society can sell your home to get back its money. Hence, it’s a loan secured against your home.

How mortgages work:
If asked to list the steps in which the mortgage works, you will come up with the following list:
• You take out a loan amount (a GBP value) based on how much you can afford and the value of the property, for a length of time agreed between you and the lender.
• You are charged interest on the loan, usually based on the Bank of England base rate, which is reviewed monthly.
• You pay the mortgage back in one of three ways, repayment or interest-only or a combination of the two.
• You can choose different deals for your interest rate, such as fixed or discounted.
• If you've had financial problems in the past and are finding it difficult to get a mortgage, the Council of Mortgage Lenders (CML) has a leaflet that may help.

If you are new to mortgages

There are the following three important things to note when you take out a mortgage (especially for novice borrowers):
• Find the mortgage that suits you and your circumstances;
• Borrow an amount you can comfortably afford; and
• Plan for changes – interest rates can go up, your income can fall, or you could lose your job.

How to repay your mortgage

Basically, when you take a loan, you have two components to repay. One, the Principle Amount – i.e. the actual amount that you took from the lender and two, the interest that gets accumulated for your loan.

You can choose to pay your mortgage back in the following ways:
• repayment – your monthly payment is split between paying off the loan (principal amount) and paying off the interest you owe on the loan;
• interest-only – your monthly payment pays only the interest charges on your loan, and you must arrange some other way to repay the principle loan; or
• A combination of the above two.

The standard mortgage term is 25 years, but you can choose a different term if it suits you and the lender agrees that you can afford it.

With a shorter term, you’ll have higher monthly payments but pay less in total. With a longer term, you’ll pay less each month but more in total.

Beware of having a mortgage term that continues past the age you retire unless you’re sure you’ll be able to afford the payments then.