We look at how mortgages work and what you can expect from the application process.
As exciting as it is to have a place that’s truly your own, buying a house is also one of the biggest financial commitments you’ll ever make. House prices have been rising steadily. So, unless you plan on winning the lottery, chances are you’ll need to take out a mortgage to finance the purchase. Here’s how to go about it.
First things first: what is a mortgage?
A mortgage is a loan used to buy a property. But, it differs from other kinds of loan in three ways:
1. It typically has a longer term
Traditionally, most mortgages run for 25 years. However, the term can be shorter or longer depending on a number of factors, including the size of your deposit (more on this later).
30, 35 and 40-year terms are increasingly becoming the norm, especially among first-time buyers. A longer term means smaller monthly repayments, which makes your mortgage more affordable. The flipside is that, the longer the term, the more interest you’ll have to pay.
2. It’s secured against the value of the property you’ve purchased
Mortgages are secured against the value of the property. If you’re not able to keep up with your monthly repayments, your mortgage provider has the right to take away your property and sell it off.
3. You cannot borrow the full purchase price
The vast majority of mortgages don’t cover the full purchase price of your new home. You’ll need to pay a portion - the deposit - out of your own pocket.
Most lenders will require at least 5% of the purchase price as a deposit. However, size really does matter. The larger your deposit, the better you can expect the terms of your mortgage to be.
What should I do before applying for a mortgage?
The extent of your options when getting a mortgage depends on your credit history, your financial situation and the size of your deposit. Most mortgage lenders have strict approval procedures, so it makes sense to be sure your finances are in order before you start enquiring.
2 - Lenders carry out affordability checks before approving a mortgage. The less you need to borrow, the more likely you are to pass these checks and get approved without any problems.
3 - The less you borrow, the less risky you’ll look in a mortgage lender’s eyes, which translates into a better interest rate.
Check your credit report
Mortgage lenders use your credit history to determine how likely you are to default on your debt. Your credit history is recorded in your credit report (and your credit score is a quick way of seeing how your report might look to lenders).
If the information in your credit report suggests you've struggled to repay credit in the past, you may appear risky to lenders. So chances are you could be offered less favourable terms on your mortgage, or get turned down altogether. Conversely, a better credit history makes it likelier that you’ll get accepted and get a good deal.
With this in mind, your first step should be to check your credit score and report before you start applying for a mortgage. If your score is less than stellar, you’ll have the chance to improve it by making changes to your credit report.
You can use ClearScore to check your credit score and report for free.
Examine your spending
In the past, mortgage lenders used to calculate how much you could afford to borrow as a multiple of your annual salary. As a rule of thumb, you could borrow up to three times your annual salary (or two and a half times your annual salary in case of a joint application).
Following the 2008 financial crisis, the rules have become much stricter. Nowadays, lenders determine how much you can borrow by making an affordability assessment. In other words, they won’t just look at your income, but also at your expenses. They’ll also consider what might happen should your financial circumstances change in the future.
You should prepare for this by gathering documentary evidence of your monthly expenses, including utility bills, other loans and even your grocery spend and mobile phone contract. Try reducing your monthly spend as much as possible, for instance by switching energy provider.
Save up for a deposit
You should try to save up as much as possible for a deposit before you start approaching lenders.
The best deals typically require 25% or more. If this sounds unrealistic, consider looking into the government’s Help To Buy scheme. Many banks also have savings plans to help you save up for a deposit.
Shopping around for a mortgage
Once you have an idea of your financial situation, it’s time to start speaking to lenders. You have two options:
1) talking to your bank
2) using a mortgage broker
Talking to your bank
Your current bank often feels like the obvious choice, because you already have a relationship. Besides, most banks offer exclusive deals and discounts on mortgages if you’re already a customer.
But while a loyalty discount might look advantageous on paper, you may be able to get a better deal elsewhere. Keep in mind that mortgage lenders are in competition with one another. it pays to compare offers before you make a decision.
Using a mortgage broker
The advantage of using a mortgage broker is that they’ll shop around for you. A good mortgage broker will also explain your options and help you choose the best deal.
For best results, use a mortgage broker who offers advice from the whole market, not just from select lenders. The broker should disclose this - as well as their fee structure - upfront.
How do I apply for a mortgage?
Applying for a mortgage goes hand-in-hand with house-hunting. Typically, it occurs in two stages:
Stage one: fact-finding You can do this at any stage of the home-buying process. However, it’s a good idea to do it before you even start house-hunting. That way, you’ll have a good idea of what your price range is before you get your heart set on a property.
At this stage, the lender will find out as much as possible about your needs and tell you how much they would be prepared to lend you. There’s no obligation to take out the mortgage, so you can talk to several different lenders in order to find out who would offer you the best terms.
Approval in principle Once you choose a specific lender, you can ask them for a decision in principle - a written statement declaring they’d be happy to lend you the amount you require.
An approval in principle makes you more attractive to sellers, because it shows you’ve done your homework and can afford to buy the property. However, it’s not a guarantee your mortgage will go through. The lender may still reject you after conducting more thorough checks.
Stage two: getting your mortgage Stage two is the application proper; and entails a credit check and a detailed affordability assessment.
Your lender will also want to value the property you intend to purchase. The property will be checked for any issues and compared to similar ones. This is the lender's way of ensuring you’re paying a suitable price for a property.
If everything is in order and the lender accepts your application, you’ll be given a legally binding offer. Your lender is now obliged to give you the funds to purchase the property. However, you’ll have a reflection period within which you can change your mind. You can waive this if you want to speed up your purchase.
Once you sign the offer, you’re good to go. As soon as all sale formalities are complete and your lender receives the title deed, the funds will be released to the seller’s solicitor and you’ll get the keys to your new home.