What is a mortgage?

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What is a mortgage?

The accepted definition of a mortgage is a loan taken out in order to purchase a property. We think of most mortgages as loans to buy our homes but in fact many mortgages are commercial mortgages used to buy business premises, or investment mortgages used to buy property to be rented or leased out.

In the UK the provision and sale of mortgages is regulated for the residential mortgage market (buying homes), but not for the commercial or investment market (commercial loans and buy to let).

In actual fact the ‘mortgage’ is not the loan at all, the term ‘mortgage’ relates to the legal charge which is placed on the property to enable it to act as security for the loan. Without the ‘mortgage’ element the loan would be what is known as an ‘unsecured loan’, meaning there is no property associated with the loan acting as security.

A mortgage can be placed on a property as a first charge, second charge, or even third charge. These terms relate to order in which the various Lenders have call on the proceeds of any future sale of the property. If your property is sold the Lender holding the first mortgage charge will have first call on the funds, followed by the Lender with the second charge, and so on – any remaining cash is returned to you.

Therefore, as well as a market for the promotion and sale of first charge mortgages, there is also a market for second charge mortgages which are called ‘secured loans’. These are loans taken out by the property owner in addition to the main mortgage (first charge) to raise further cash and are secured on the property behind the main mortgage as a ‘second charge’.

Mortgage is a term in Legal French meaning ‘death contract’ – this means that contract ends when the obligation is fulfilled, or the property is retaken by repossession.

‘Death contract’ sounds like a serious term and so it should. A mortgage is not an arrangement to be taken lightly, particularly when you are using the mortgage to buy your main home. Failure to repay the mortgage within the terms of the contract may result in repossession and the loss of your home.

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Why do we need mortgages?

Contact A Mortgage NowMost of us need mortgages due to the high cost of property in the modern world. With average earnings not far above £30,000 and the average price of a terraced house in the UK £189,000, a quick calculation can establish how long it would take to save the full funds to purchase a property without a mortgage.

We therefore have a system that is set up give us what we need, a mortgage to buy now when we need the property, and the mechanism to repay as we are living in the property by paying back both the capital and the interest on the mortgage.
Typically, in the UK, mortgages are taken out over 25 years, but this is no hard and fast rule, it is just the way that the mortgage market has evolved over time. The longer your mortgage term the more mortgage interest you will pay overall when buying your property – therefore it makes sense to take the shortest mortgage term affordable.

In many other countries in the world mortgage terms are limited to ten years which gives most householders a chance to own their property outright at a reasonable age. Without the mortgage as a means of financing a property purchase, there would be far fewer of us owning our own homes or business premises.

In recent years, as property prices have increased, it has become common place for the householder to focus on the increasing value of their home rather than reducing their mortgage. As a result, more and more mortgage holders are refinancing to ‘take equity’ from their property to support their lifestyle.

As the mortgage market has shrunk and higher deposits are demanded we are also seeing parents and grandparents raising new mortgages against property they already own outright in order to provide mortgage deposit funds for their children or grandchildren.

How can I get a mortgage?

Your ability to get a mortgage is based on a number of factors. The primary ones are:

  • Security – is the intended property suitable as security for a mortgage?
  • Status – is your income sufficient to manage the capital and interest repayments?
  • Serviceability – are you likely the make the repayments?
  • Security is dealt with by carrying out a valuation or survey on the intended purchase property. This is usually paid for by the mortgage borrower and the intention is to establish in simple terms if the Lender is likely to quickly and easily get their money back on a forced sale should they need to repossess. Therefore the higher the deposit, the lower the loan to value ratio on the mortgage and the less concerned the Lender will be with the total property value.

    On the lower loan to value mortgages the Lender will be concerned with the condition of the property and will want to ensure that the property is in a good state to sell if it becomes necessary.

    Status is an element of the Lenders criteria on which focus was lost during the early years of the 21st century. Lenders were relying on the increasing value of the properties to cover their position on their mortgage book and this led to the rise of the self-certified mortgage. In a self-certified mortgage arrangement the status of the applicant was either checked only to a modest level, or not checked at all.

    Since 2010 the self-certified mortgage is no longer available in the market and all applicants will undergo a status check. For the employed applicant this means being asked to provide wages slips and P60’s (and sometimes an employer’s reference). For the self-employed applicant this means providing an accountants reference, full accounts, or, as is increasing the case, SA302 self-assessment tax returns.

    Serviceability is about your intention to pay if you are in a position to do so. To establish this when considering a mortgage, the mortgage lender will look at your financial history using your credit file and your bank statements.
    Bank statements show your income and outgoings, they identify for the bank if there are any unusual or excessive payments or expenditure.

    If you have an overdraft the mortgage lender will be looking at how that overdraft is managed and if the agreed overdraft limit is ever exceeded. Items such as regular monthly payments over £200, or single transactions over £500, may lead the lender to ask further questions for clarification.

    The other big factor in the serviceability consideration is the availability of the credit report or credit file.

    All UK adults have a credit report available on file through one of the major providers such as Expirian, Equifax or Call Credit. These credit files are a combination of information from all the Banks, Mortgage Lenders, Loan Providers and Credit Companies in the UK.

    Every time you apply for, or take credit, it can be noted on your credit file. Every time you make a payment it will be noted on your credit file. Every time you fail to make a payment it is also noted on your credit file. Your credit file will include details or mortgages, loans, overdrafts, credit cards, HP, and mobile phone accounts.

    The availability of the credit file has made the credit search a main stay of the UK mortgage application process. It can be completed and scored automatically, inexpensively and simply, in seconds.

    What is the risk of a mortgage?

    Contact A Mortgage NowWhen you take a mortgage to buy your property you may move in and the place feels like home straight away. In fact the decision on whether the property continues to be your home can be taken out of your hands by your lender at any time if full payments are not made under the terms of the mortgage contract.

    Rising interest rates
    If the interest rate payable on your mortgage rises you may find it difficult to continue to make full and regular payment. Therefore if your budget is tight you should consider a fixed rate mortgage to protection yourself against interest rate rises. Payments on a fixed rate mortgage are guaranteed to stay the same for an agreed period of time.

    Lower or lost income
    If you lose your job, or are sick or injured and unable to work, you may find it difficult to maintain your mortgage payments from savings for an extended period. Fortunately there are a number insurance options that can reduce or eliminate this risk.

    Death
    If you die, your mortgage debt does not die with you and this can be a major problem for your family as they may lose their home Fortunately, the simple addition of life insurance to your planning arrangements can protect your family against your death.

    What is the benefit of a mortgage?

    A mortgage is the most cost effective way to buy a property in a managed and carefully budgeted way whilst benefiting from being able to live in the property.

    If the value of the property increases, that increase in value becomes your asset and the mortgagor does not benefit from it. If the property is your primary private residence there is no capital gains tax to pay on any increase in the value of your property (under current tax legislation).

    What type of mortgage is available to me?

    Contact A Mortgage NowMortgages come in all forms to suit a wide range of circumstances.
    The first question is what kind of property do you intend to purchase with your mortgage?

    If you intend to live in the property you will need a residential mortgage, if you are letting out the property you will need a buy to let mortgage. A commercial property such as a business premises will need a commercial mortgage.

    Residential mortgages come in two main forms, repayment mortgages, and interest only mortgages. With a repayment mortgage arrangement you service the interest on the loan each month as well as repaying a little of the capital.

    With an interest only mortgage you are only servicing the interest through your monthly payment and will then have to repay the capital element in full at the end of the mortgage term.

    If buying a property as your home a repayment mortgage is the recommended option in most cases.

    Once you have decided on repayment or interest only mortgage, you need to consider the product type. There are two major types of mortgage product, the fixed rate mortgage, where the interest rate is fixed for a period of time, and the tracker or variable rate mortgage, where the interest rate on your loan can vary.

    Your own personal circumstances will dictate which lenders will be prepared to offer you mortgage lending and therefore which products are available.

    How do I get started with my mortgage application?

    To arrange a mortgage you need to apply to a mortgage lender.

    Applications can be made direct to some lenders but more commonly a mortgage broker is consulted. A mortgage broker will know which lenders are suitable for your own circumstances and will you save wasted time and frustration.

    An independent mortgage broker will have access to the whole of the mortgage market and will recommended the most suitable mortgage product for you before handling the full application process on your behalf.

    Before you make a start with your mortgage application make sure that you can prove your income, are confident it will continue, finally be sure you are ready for the long term commitment of a mortgage.

    If there is anything in your circumstances that you feel may cause a problem with your mortgage application, for issues on your credit record, make sure you inform your mortgage broker at outset so that they are best placed to assist you.

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