How mortgages work - A step by step guide

A mortgage is essentially a loan to help you buy a property. You’ll usually need to put down a deposit for at least 5% of the property value, and a mortgage allows you to borrow the rest from a lender.

You’ll then pay back what you owe monthly, generally over a period of many years. Mortgage terms often run for 25 years, but lenders may allow longer or shorter terms than this. You’ll typically pay interest on the amount borrowed each month too, either at a fixed or variable rate of interest, depending on which type of deal you choose.

The loan is secured against your property until it has been repaid in full.

Lisa Parker
November 30, 2022

How does the interest on a mortgage work?  

The amount of interest you’ll pay on your mortgage depends on the mortgage deal you’ve chosen. If, for example, you go for a fixed rate mortgage for a set period of time, then during this period the amount of interest you’ll pay will stay the same every month.

When the fixed rate period ends, you’ll usually be automatically transferred onto your lender’s standard variable rate, which will typically be higher than any special deal you’ve been on. At this point you’ll see your interest payments increase. However, you will be free to remortgage to a new mortgage deal, which may help keep your payments down.

If you choose a variable rate mortgage deal, then the amount of interest you pay can fluctuate over time. If interest rates fall then this drop could be passed on to you, and you will see your monthly payments go down as a result.

If mortgage rates increase however, then borrowing costs become steeper for lenders, and these higher costs are typically passed on
to homeowners. In this case your monthly payments would go up. That's why many home-buyers opt for fixed rates to provide peace of mind that their interest rate and monthly payments won't change.

In the early years of your mortgage, a larger proportion of your monthly payment goes towards paying off your interest, and a smaller amount towards your capital. Gradually, you’ll start to pay off more of your capital over time as your debt reduces.

How do mortgages work when selling or moving house?  

When you sell your property or move house, you’ll usually have various different mortgage options available.

Many mortgages allow you to ‘port’ them to a new property, so you may be able to move your existing mortgage across to your next home. However, you will effectively have to apply for your mortgage again, so you’ll need to satisfy your lender that monthly payments remain affordable. It’ll be down to them to decide whether they’re happy to allow you to transfer your current deal over to your new property. Bear in mind too that there may be fees to pay for moving your mortgage.

If you’ll need a bigger mortgage to move to a new home, you may decide to move your existing deal across and then ask your lender if you can borrow the additional funds you need. Remember, however, that if you do this, any extra borrowing may be at a different rate.

If you’re not tied into your current mortgage deal and there isn't an Early Repayment Charge to pay if you leave it, you could remortgage with a different lender for the amount you need for your new property.

Remember that you’ll need to be certain you can afford your new mortgage before you apply. Lending criteria is much stricter now than it was a few years ago, and lenders will usually want to go through your finances with a fine tooth-comb to check you can manage the monthly payments before they’ll offer you a mortgage.

If there’s going to be a gap between the sale of your home and the purchase of your new property, some people apply for what’s known as a ‘bridging loan’ to bridge this gap. This type of loan means you can move into your new property before you’ve sold your home. However, these should only be considered a last resort as they usually have higher interest rates and fees. Seek professional advice if you’re unsure, and if you’re considering this type of loan you must be comfortable with the risks involved as you’ll essentially own two properties for a period of time.

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