Residential mortgages

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 for residential use - in other words, to live in. All properties with a current residential mortgage must be used as a permanent residence by at least one of the borrowers, and not rented out to tenants or used for any other commercial purposes.

Usually, a residential mortgage is taken over a relatively long period of time, 30 years being the current UK average. The loan is paid back monthly with interest until you own the property outright. Due to the high loan amount - usually more than four times the borrower's income - a deposit is required to balance some of the risk to the lender.

How much is a residential mortgage deposit?

Residential mortgages require a cash deposit of typically between 5% and 40% of a home’s value.

A mortgage for a £200,000 home would likely require an upfront deposit of anything between £10,000 and £80,000.

It's sometimes possible to borrow 100% of the cost of a property, either by using a guarantor mortgage or family assisted mortgage. There is also one product currently on the market offering 100% mortgages to renters looking to buy.

What is the 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: Buying a £200,000 with a deposit of £40,000 - you'd need to borrow £160,000. This is 80% of the total value of the property or 80% LTV. 

There's no set LTV for residential mortgages, but generally, 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. It works in the same way, no matter what type of mortgage you have - it's charged as a percentage on what you borrow.

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 APRC 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.

How much will I pay?

The type of interest rate you choose and your financial circumstances influence the residential mortgage rates available to you. Most residential mortgages are capital repayment, so 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-only mortgages and part and part mortgages work differently, however:

How are my monthly repayments calculated?

With any mortgage, you make monthly payments over the full mortgage term. No matter what repayment type you choose, the longer the mortgage term, the smaller the monthly repayments - but the more interest you’ll pay overall.

The different repayment methods are:

Capital repayment

Often simply referred to as a repayment mortgage, this 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. This means you'll have fully repaid your mortgage at the end of the term.

Interest-only repayment

Not often used to buy residential homes, interest-only mortgages are typically seen in buy-to-let mortgages - property bought specifically to rent out. Some lenders offer interest-only residential mortgages in certain circumstances, however. They can also be used as a temporary measure when the borrower is struggling to afford their capital repayment mortgage.

As expected, with interest-only mortgages, you only pay the interest charged on your mortgage each month. Although this means that your monthly repayments are cheaper, you'll still owe everything you borrowed at the end of the mortgage term.

This means once the term ends, the home will need to be sold or an alternative ‘repayment vehicle’ (investments or savings that have been pre-approved by the mortgage lender) is used to repay the loan capital.

Part repayment and part interest-only 

Part and part mortgages, as they're often known, are relatively uncommon. However, they can be a good balance between a repayment and interest-only mortgage if you're struggling with costs, but want to minimise how much you'll owe at the end of your mortgage.

Lenders will still need to be comfortable with your chosen method of repaying the final balance, but there will be less to repay - as you'll have repaid part of the capital monthly.

What are the different types of residential mortgage rate?

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

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 few 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 fall, you won't benefit until your fixed deal ends, 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 at any time during the deal period. Whilst you agree to an initial rate of interest, there's no guarantee it will stay at that level. There are two types of variable rate deal:

Tracker rate mortgage - A tracker deal follows the Bank of England’s base rate, so rises and falls in line with it. Typically rates are offered at a certain percentage above the base rate.

For example: If the base rate is 5%* + 2%, you pay 7% interest at the beginning of the deal. If the base rate rises by one percentage point, you'd pay 8%, as the percentage that the lender charges (in this case 2%) would stay the same for the length of the deal.

*For demonstration only, the actual UK base rate is 5.25%

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 (swap rates). 

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 to find the best residential mortgage rates

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

This can be a difficult decision, especially when rates are high. As a first-time buyer, in particular, taking advice from a mortgage broker is highly recommended. 

Even if you've had a mortgage for many years, the volatile market we currently have can make selecting the right type of mortgage rate a tough call. Our broker partner, Mojo mortgages, provide free advice and recommendations.