Residential mortgages

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 £292,000 in July 2022, so wherever you're buying, unless you’re lucky enough to have hundreds of thousands of pounds in savings, you’ll probably need to borrow a great deal of money to do so.

A residential mortgage is a large long-term loan taken out by one or more individuals to buy a home for residential use. Whether you are a first-time buyer, selling up and buying a new home to move into or remortgaging, you will need one if you plan to live in the property yourself.

A residential mortgage must be used as a residence by at least one of the borrowers, not rented out to tenants or used for any other commercial purposes.

A residential mortgage is typically taken over a relatively long period of time, 30 years being the current average, as at 2022. The loan is paid back monthly with interest until you home the property outright. 

It works similarly to any other form of loan, however, as it’s on a grander scale, a deposit is required to balance some of the risk to the lender. This is because most people borrow between four and four and a half times their annual income, with people in certain circumstances able to borrow even more than that.

Residential mortgages require a cash deposit, typically of between 5% and 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 (LTV)is how much you’re borrowing (loan) compared to the price (value) of the home you’re buying. 

For example, If you want to buy a property that is £200,000, but have a deposit of £40,000, you will need to borrow £160,000. You are therefore borrowing 80% of the total cost of your home or 80% LTV. 

The lower the percentage of the LTV, the smaller the risk for the lender and therefore, the better the interest rate you’ll be offered.

Interest is the ‘fee’ a lender charges for providing the service of lending it to you, and the type of interest rate you choose, as well as your own circumstances, will influence how much interest you pay.  It's charged at a certain percentage on the full outstanding mortgage value.

Interest is typically charged monthly, but expressed as an annual figure, so lenders must show the annual percentage rate of charge (APRC). This includes the cost of any mortgage fees and charges, to help you compare the total cost of deals between lenders. 

The problem with relying too heavily on this figure is that it assumes you will have the mortgage for the whole length of the term. Whilst some people may choose to do so, most  switch to a new deal at the end of each deal period to avoid paying the lender’s standard variable rate of interest (SVR) which is usually higher. 

It also assumes the rate won’t change if you do stay on the deal, making it a less accurate measure to compare variable rate mortgages, which can change at any time throughout the term.

With a repayment mortgage, which is the most common type used for residential purchases, the interest you pay will reduce as your balance decreases. This means that over time, the proportion of your monthly repayment that goes towards paying off the interest decreases, but the proportion going towards the balance increases. This is known as amortisation. 

Graphic: Mojo Mortgages

When you first take out a mortgage, you usually choose a deal, rather than the lender’s default rate of interest (SVR) which is higher. You can either opt for a fixed-rate of interest or a variable rate of interest:

Fixed-rate deal

A fixed rate of interest is just that, it will not change for the length of the deal, it’s fixed at the initial rate you are offered. Fixed rate deals are available for as little as two years and as long as the entire mortgage term (sometimes as long as 40 years) although two, five and ten year deals are most common. 

Fixed rates are great for budgeting, as if interest rates rise, your repayments will not become more expensive. Of course, if rates fell, you would not benefit from them until your fixed deal was over, unless you pay additional fees known as ERCs (early repayment charges). 

Variable rate deal

A variable rate of interest can go up or down during the deal period, so whilst you will agree to an initial rate of interest, there is no guarantee it will stay at this level. There are two types of variable rate deal:

Tracker rate mortgage - A tracker rate deal follows the Bank of England’s base rate, so will rise and fall in line with it. It is typically offered at a certain percentage above the base rate, for example, your mortgage could be the base rate (currently 3.5%) +2%, so you would be paying 5.5% interest at the beginning of the deal.

If the base rate then rose to 4%, however, your interest rate would rise to 6%, and if it fell to 2.5%, your interest rate would fall to 4.5%.

Discount rate mortgage – A discount rate mortgage is based on the lender’s own standard variable rate and offered at a set discount on that. Your interest rate will therefore vary entirely at the discretion of the lender. 

Whilst lenders can raise their SVR whenever they choose, they are also influenced by wider market changes, such as changes in the Bank of England base rate or an increase in the cost of borrowing. 

Monthly repayments will need to be met until the mortgage is repaid. The repayment term on a typical residential mortgage is around 25 years but can be longer or shorter. Not being able to meet these repayments could result in losing your home.

With any mortgage, you will need to repay the total amount you borrowed, plus interest on that amount over the full mortgage term. 

For example, if you were charged 3% interest on a £150,000 mortgage taken out over 25 years, after making monthly repayments of £711 for a year (a total of £8,532 over the year), you would still owe £145,907. 

The longer the repayment schedule the smaller the monthly repayments will be, but the more interest you’ll pay overall and vice versa. There are two main ways that you can repay a mortgage, and the chosen method will also impact how much you pay each month:

A repayment mortgage is by far the most common way to repay a residential mortgage. It involves repaying an element of the capital (amount borrowed) and an element of the interest each month. 

With a repayment mortgage (sometimes known as a capital repayment mortgage) you will have fully repaid your mortgage at the end of the term.

Not often used to buy residential homes, interest-only mortgages are typically offered to those looking to invest in property to rent out for profit. There are a few lenders who may still offer this repayment option to residential home buyers in certain circumstances, however. 

With this repayment type, you only pay the interest charged on your mortgage each month. Whilst this does mean that your monthly repayments will be cheaper, it’s important to understand that this method will not repay the capital on your mortgage. This means that when you complete the term, you will still owe everything you borrowed at the beginning. 

This means that the home will need to either be sold at the end of the term in order to repay the loan, or you can use an alternative ‘repayment vehicle’ (investments or savings that have been pre-approved by the mortgage lender). 

It may be possible to remortgage onto a repayment mortgage at the end of the term in order to repay the loan, however, bear in mind that you may be unable to qualify for another lengthy mortgage term at this point in your life due to mortgage age limits. 

Part repayment and part interest only 

Some lenders offer a mixture of the two repayments types above, which means that you can have lower monthly payments than with a repayment mortgage and still have paid off some of the capital, leaving you less to find at the end of the mortgage term.  

This repayment type is far less common, however, and the lender will still need to be comfortable with your chosen method of repaying the remaining balance at the end of the term. 

A residential mortgage is secured on your home to protect the lender’s money. This means that if you default on paying the mortgage the lender has a right to repossess your home. 

Repossession is where a lender can legally evict you and sell your home in order to repay your mortgage. If you are concerned about defaulting on your mortgage read our managing debt guide for more information.

It’s always important to compare the deals available to see which one best suits your circumstances, as every mortgage has different criteria and terms, as well as different interest rates and types. 

It can be difficult to make this decision, especially as a first-time buyer, so taking advice from a mortgage broker with in-depth knowledge of the different types of mortgage available across the entire market, is recommended.  

Remember to look at the whole cost of the mortgage, as those with lower fees often have higher interest rates, and vice versa.