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.

The average home in the UK currently costs around £188,000, but there are big regional variations – in London the average is over £400,000.

Wherever you are buying, unless you’re lucky enough to have hundreds of thousands of pounds in savings, you will need to borrow a great deal of money. This is where a residential mortgage comes in.

What is a residential mortgage?

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 chose 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.

Deposit

Residential mortgages require a cash deposit, typically between 10-30% of a home’s value.

For example, a mortgage for a £200,000 home would likely require an upfront deposit of anything between £20,000 and £60,000.

Some residential lenders could ask for less than a 10% deposit to entice first-time buyers, and the government’s Help to Buy scheme means those who qualify only need to stump up as little as 5% of the value of your home.

Loan to value ratio (LTV)

Your loan to value is the amount borrowed set against the value of the property.

If you have a deposit of £40,000, 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 ratio, with your £40,000 deposit accounting for the remaining 20%.

Loan to value ratios of 80% and lower are typically seen as low LTV ratios, whereas LTVs over 90% are considered higher. The lower the ratio, the smaller the risk for the lender and the better the interest rates offered to the borrower.

What LTV can I get?

The best rates come with 60% LTV mortgages which are the lowest available LTV mortgages.

In the middle there are 80%75% LTV mortgages, 70% LTV mortgages and  offer very competitive rates with manageable monthly repayments.

95% LTV mortgages, 90% LTV mortgages and 85% LTV mortgages are all at the high end of available LTVs. These may have more expsensive rates, but offer a way for first time buyers to buy a home.

The highest LTV you can is with a 100% LTV mortgage but these are rare. They requires no deposit but often charge very high rates of interest and require guarantors.

Interest

Interest will be charged on the value of the mortgage owed. Interest is the cost of money, or the ‘fee’ a lender charges for providing the service of lending you money. It is charged as an annual percentage rate against the value of your debt.

This means you will have to repay the value of your mortgage plus interest. For example if you were charged 5% interest on a £160,000 mortgage you would still owe £156,776 at the end of a year, which is £160,000 + £8,000 (5% interest) – £11,224 (monthly repayment of £935 x 12).

However, you are very unlikely to enjoy a fixed interest rate for a lifetime of a mortgage although it can be managed in three ways:

• Fixed rate mortgage – This gives you set monthly repayments for a number of years, typically between 2 to 5 years, but sometimes as long as 10 years. They 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 2.5%.

• Variable rate mortgage – Your interest rates will vary at the discretion of the lender. This means that the cost of your mortgage could (and likely will) be increased from the initial rate. However, this is unlikely to be a severe or sudden increase as a mixture of competition and fear of bad publicity tends to stop variable mortgages hiking up to high rates.

Monthly repayments

There will be monthly repayments that will 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 amount of interest being charged.

The repayment schedule on a typical residential mortgage is around 25 years. The longer the repayment schedule the smaller the monthly repayments and vice versa. You can remortgage if your circumstances have changed and you want to pay back the debt faster or slower.

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.

There are two types of repayments:

• Full repayments – This repays the full value of your mortgage. Your repayments back a small chunk 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 – This will only pay the interest charged on your mortgage, which whilst cheaper, does mean you will never repay your mortgage. Typically the mortgage will be repaid at the end of the term by selling the home, remortgaging or using a ‘repayment vehicle’ (an investment or saving that matures alongside the mortgage).

Both options have pros and cons, which one you chose depends on whether you want cheaper monthly repayments or to work towards being mortgage free faster.

Secured against the home

A residential mortgage is secured against the home to protect the lender’s money. This means that if repayments are consistently not met and a borrower defaults on paying the mortgage the lender has a claim on the home.

To recoup the money lent the lender may evict the residents and sell the house, using the income from the sale to clear the mortgage debt. This is known as foreclosure and is usually the final resort.

If you are concerned about defaulting on a mortgage read our managing debt guide for more information.

What kind of a borrower are you?

Residential mortgages can be tailored to fit the needs of different home buyers.

• Remortgaging? – If you already have a mortgage changing to a new one could get you a better deal on your monthly repayments or give you an opportunity to consolidate your debts under a better rate of interest. It could be worth moving from a fixed rate plan to a variable or tracker mortgage to seize better rates, or vice versa for security. You will have to pay a fee for switching though, so make sure that what you will save more than you pay.

• 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 you can get a new one. Porting a mortgage is like remortgaging with your existing lender. Getting a moving home mortgage could give a better deal, but if you are leaving your old mortgage before its expiry, 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 you can afford (if you need more money, consider the Help to Buy scheme) and that you can afford the monthly repayments.

If you wish to take out a variable or tracker mortgage make sure you’ve budgeted for potential rate rises. To know you can afford your repayments it could be sensible to use a fixed rate mortgage until you’re secure.