Residential mortgages

A residential mortgage is a large long-term loan taken out by one or more individuals to buy a home for residential use - in other words, to live in. Whether you're a first-time buyer, moving to a new home or remortgaging, you'll need one if you plan to live in the property yourself.

A property with 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.

How a residential mortgage works

A residential mortgage is typically taken over a relatively long period of time, 25-30 years being the current average. The loan is paid back monthly with interest until you own the property outright. 

It works similarly to any other form of loan, but due to the high loan amount, 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.

How much is a residential mortgage deposit?

Residential mortgages require a cash deposit, typically 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.

What is loan to value (LTV) for residential mortgages?

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's £200,000, but have a deposit of £40,000, you'll 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.

How does interest on a residential mortgage work?

Interest is the fee a lender charges for providing the service of lending to you. 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 percentage of the remaining outstanding mortgage value if you have a repayment mortgage and the interest you pay reduces as your balance decreases. Over time, the proportion of your monthly repayment that goes towards paying off the interest, therefore decreases, but the proportion going towards the balance increases. This is known as amortisation. 

Graphic: Mojo Mortgages

Interest is usually 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'll have the same mortgage deal for the whole length of the term. Whilst some people may do, 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.

What are the different types of residential mortgage interest rate?

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 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're offered. Fixed rate deals are available for as little as two years and as long as the entire mortgage term, but two, five and ten year deals are most common. 

Fixed rates are great for budgeting, as when interest rates rise, your repayments won't go up. Of course, if rates fell, you wouldn't benefit until your fixed deal was over, unless you pay additional fees known as ERCs (early repayment charges) to leave the deal early.

Variable rate deal

A variable rate of interest can go up or down during the deal period, so whilst you'll agree to an initial rate of interest, there's 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 4.5%) +2%, so you would be paying 6.5% interest at the beginning of the deal.

If the base rate then rose to 5%, however, your interest rate would rise to 7%, and if it fell to 2.5%, your interest rate would fall to 4.5%.

Discount rate mortgage – A discount rate mortgage is offered at a set discount on the lender’s own standard variable rate. Your interest rate will therefore go up or down 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. 

How are my monthly repayments calculated?

With any mortgage, you'll need to make monthly payments 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.

Capital and interest repayments

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. 

Sometimes known as a capital repayment mortgage, this method means you'll have fully repaid your mortgage at the end of the term.

Interest-only repayments

Not often used to buy residential homes, interest-only mortgages are typically used on buy-to-let mortgages - for property bought specifically to rent out. There are some lenders who may offer interest-only residential mortgages to home buyers in certain circumstances, however. 

With this repayment type, you only pay the interest charged on your mortgage each month. Although your monthly repayments are cheaper, you will not repay any of the capital on your mortgage. This means that you'll still owe everything you borrowed at the end of the mortgage term.

The home will need to either be sold to repay the loan, or you can use an alternative ‘repayment vehicle’ (investments or savings that have been pre-approved by the mortgage lender). This is why it's more suited to landlords than residential home buyers.

Part repayment and part interest only 

Some lenders offer a mixture of the two repayments types above, allowing you some of the benefits of both. You can have slightly lower monthly payments than with a repayment mortgage but still pay off some of the capital, leaving you less to money 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 final balance.

What happens if you don't make your monthly mortgage repayments? 

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. Our guide on what to do if you can't afford to pay your mortgage, has some helpful tips.

How do you find the best residential mortgage?

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 is highly recommended.  

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