Residential mortgages are the largest, and one of the most common, forms of credit in the UK, and make it possible for millions of us to buy our homes.
According to the Office for National Statistics the average house price in the UK was £270,000 in September 2021 but there are big regional variations – in London it was a massive £507,000.
So wherever you're buying, unless you’re lucky enough to have hundreds of thousands of pounds in savings, you’ll need to borrow a great deal of money. This is where a residential mortgage comes in.
A residential mortgage is a large long-term loan taken out by one or more individuals to buy a home to live in.
Whether you are a first-time buyer, moving home or remortgaging, this is the type of mortgage you will need. Depending on what is best for your circumstances you can choose between fixed-rate, variable or tracker mortgages.
With a residential mortgage the home must be used as a residence by the borrowers, not rented out to tenants or used for commercial purposes.
When taking out a residential mortgage, there are many things to take into consideration, such as the deposit, your monthly repayments and the interest rate that will apply.
Residential mortgages require a cash deposit, typically of between 5-40% of a home’s value.
For example, a mortgage for a £200,000 home would likely require an upfront deposit of anything between £10,000 and £80,000.
Your loan to value is the proportion of the value of the property you are borrowing.
If you have a deposit of £40,000, for example, you will need £160,000 to be able to afford a £200,000 property. Borrowing £160,000 for a £200,000 home gives you an 80% loan to value, with your £40,000 deposit accounting for the remaining 20%.
LTVs of 80% and below are typically seen as lower LTVs, whereas LTVs over 90% are considered higher. The lower the LTV, the smaller the risk for the lender and the better the interest rate you’ll be offered.
Interest will be charged on the value of the mortgage owed. Interest is the cost of borrowing the money, or the ‘fee’ a lender charges for providing the service of lending it to you.
It is usually charged monthly on your outstanding debt but expressed as an annual figure. Lenders must also show the annual percentage rate of charge (APRC), which includes the cost of any mortgage fees and charges, to help you compare deals between lenders.
However, this figure assumes you’ll have the mortgage for the whole term rather than switching to a new deal at the end of the deal period, as you should usually do to avoid paying your lender’s higher standard variable rate. It also assumes the rate won’t change even though a variable rate will apply to at least part of the term.
You’ll have to repay the amount of your mortgage plus the interest. For example, if you were charged 3% interest on a £150,000 mortgage taken out over 25 years you would still owe £145,907 after a year with monthly payments of £711 (a total of £8,532 over the year).
The interest you’ll pay over time will go down as your balance decreases. However, as your mortgage payment stays the same each month (as long as the interest rate doesn’t change) the proportion of it going towards paying off the interest decreases over time while the proportion going towards the balance increases until you’ve paid off the mortgage. This is known as amortization.
You can see how this works in the graph below.
Graphic: Mogo Mortgages
When you first take out a mortgage, you get an initial period – usually of between two and five years – where the interest rate is discounted from the lender’s standard variable rate. These fall into three categories:
Fixed-rate mortgage - This gives you set monthly repayments for the initial deal period, which can sometimes be as long as 10 years. Fixed rates can be very beneficial if interest rates rise significantly as your repayments will not become more expensive, however you will not benefit from falling interest rates.
Tracker mortgage - This will be pegged to the Bank of England’s base rate with a pre-agreed mark up, for example, your mortgage could be the base rate +2%, so currently you would be paying interest of 2.1%.
Discounted variable-rate mortgage – Your interest rate will vary at the discretion of the lender. This means that the cost of your mortgage could be increased from the initial rate. However, this is unlikely to be a severe or sudden increase as it’s usually influenced by changes in the Bank of England base rate.
There will be monthly repayments that need to be met until the mortgage is repaid. Not being able to meet these repayments could result in losing your home. These repayments will increase or decrease with the interest rate being charged.
The repayment term on a typical residential mortgage is around 25 years but can be longer or shorter. The longer the repayment schedule the smaller the monthly repayments but the more interest you’ll pay overall and vice versa. You can remortgage if your circumstances have changed and you want to pay back the debt faster or slower, although this probably won’t be worth doing if you will have to pay early repayment charges to do this.
Many lenders have an upper age limit of 75 at the end of the mortgage agreement. So, for example a 65-year-old would typically have to agree to repay a mortgage within 10 years. Some have no limit though or go up to 85 or even 95.
There are two types of repayment:
Capital and interest repayments – These repay the capital of your mortgage as well as the interest. Your repayments go towards paying back some of the money you have borrowed as well as interest. This means you will have fully repaid your mortgage at the end of the term.
Interest-only repayments – These will only pay the interest charged on your mortgage, which, while cheaper, does mean you will never repay your mortgage. Typically the mortgage will be repaid at the end of the term by selling your home, remortgaging or using a ‘repayment vehicle’ (an investment or savings account that matures alongside the mortgage). This can be risky though as there is no guarantee you’ll have enough to pay off the mortgage at the end of the term.
Both options have pros and cons. You should think carefully about which one is best for you but whether a lender will offer you an interest-only mortgage depends on its lending policy and your circumstances.
A residential mortgage is secured on your home to protect the lender’s money. This means that if repayments are consistently not met and you default on paying the mortgage the lender has a claim on your home.
To recoup the money lent the lender may evict you and sell the house, using the income from the sale to clear the mortgage debt. This is known as repossession and is usually the final resort.
If you are concerned about defaulting on your mortgage read our managing debt guide for more information.
Residential mortgage deals are aimed at different types of borrower:
Remortgaging? – If you already have a mortgage, changing to a new one when your initial deal ends could get you a better deal on your monthly repayments or give you an opportunity to consolidate your debts with a better rate of interest. It could be worth moving from a fixed-rate deal to a variable or tracker mortgage to take advantage of lower rates, or vice versa for added security. You will have to pay early repayment charges to switch during the deal period so it’s usually best to wait until these no longer apply.
Moving home? – You can either take your existing mortgage with you to the new property – a process commonly referred to as ‘porting’ a mortgage – or get a new one. Getting a new moving home mortgage could give a better deal, but if you are leaving your old mortgage before the end of the initial deal, you might have to pay penalties.
First-time buyer? – As a first-time buyer this will likely be your biggest financial commitment yet. So before taking out a mortgage it’s important to make sure your credit score is in good shape, your deposit is as big as possible (if you need more money, consider the Help to Buy scheme) and that you can afford the monthly repayments.
If you decide to take out a variable or tracker mortgage make sure you’ve budgeted for potential rate rises. To be sure that you will be able to afford your repayments it might be best to use a fixed-rate mortgage until you’re more financially secure.