What is a mortgage? The basic elements of a mortgage.

A mortgage, in essence, is a loan taken out by an individual specifically intended for the purchase of property. Because the purchase of real estate is more expensive the any other purchase that an individual is likely to make in the course of his life, the choosing of a mortgage may be the single most important financial decision in ones life.

A mortgage is a beneficial system as far as the lender is concerned because, in addition to paying the amount you have borrowed you also have to pay interest. The interest is the source of the lender's profit.

A mortgage is comprised of two important elements. One is the capital amount and the other is the interest. In addition to these two elements there are also other important elements to consider. In the following we will give a brief description of each of the elements that make up a mortgage agreement.

Capital Amount

The capital amount is the amount that you will receive. The capital amount usually ranges from 75% to 95% and even 100% of the purchase price. This ratio is called LTV ( loan to value ). The rest of the amount, with the exception of the 100% LTV, has to be deposited with the lender which, once you are in the final stages of the purchase will deposit the full purchase amount in the account of the seller.

The lower the capital amount is, out of the purchase price, the more advantages you can obtain from the lender. When you deposit, let's say 25% of the purchase price with the lender your credibility rises and your interest rate lowers because the risk of you not being able to pay is significantly smaller as far as the lender is concerned. The interest rate will only be applied to the capital amount and not the whole purchase price.

One more thing that you should consider when deciding what you want your LTV is that the interest rate you will be earning by keeping money in a savings account is significantly lower than the interest rate you will be charged for the capital amount of the mortgage. In other words, it makes sense to put down as much as you can as an initial deposit rather than retaining the amount in order to put it into a savings account.

Interest Rate

The interest rate determines the amount of money that you will be paying to the lender in the long run, in addition to repaying the capital amount. Lenders offer different general interest rates depending on your profile and offer different capital sum payment options.

Variable Standard Interest Rate

A mortgage with variable interest is a mortgage who's interest rate changes in accordance with the base lending rate set by the Bank of England. Every lender has a standard rate of interest on which it bases all it's offers. The standard interest rate that lenders have is usually 2% above that set monthly by the Bank of England.

Fixed Interest Rate

A fixed interest rate is a rate that you and your lender have agreed upon and that will be applied to the mortgage for a fixed period of time, usually from 1 to 5 years. This rate will not change regardless of the fluctuations of the lender's variable standard rate. After the agreed period of time has expired you interest rate will change to a variable standard interest rate model.

Capped Interest Rate

A capped interest rate is an interest agreement that let's you take advantage of falling interest rates but also sets a maximum interest rate that you can be charged in case interest rates go up. If interest rates go up, your interest rate will not exceed the maximum agreed interest rate even if the variable interest rate exceeds it. The capped interest rate only applies during a agreed period of time at the beginning of the mortgage agreement. After that period of time, the interest will be switched to a variable standard interest rate model.

Discount Interest Rate

The discount interest rate is a interest rate that you and the lender agree to apply to the mortgage. This type of interest rate is agreed to always be a set percentage lower that the lender's variable standard interest rate or in the case of base tracker interest rates a set percentage over the base lending rate of the Bank of England. These discounts are applied for the first 1 to 5 years of the mortgage after which the mortgage interest rate reverts to the lender's standard variable interest rate.

Mortgage Fees

There are also other costs associated with establishing a mortgage, other than the interest. These costs can be divided into four categories: set-up fees, administrative fees, early repayment fees and exit fees.

Many of these fees are evident to you when the offer is presented to you by there are some that are somewhat hidden. Although our other guides treat the full range of fees in detail the present guide will only give examples of the more usual evident fees that apply to most mortgages.

Set-up fees

Although you might be subject to a couple of set-up fees, the most common fee for the establishing of a mortgage is the arrangement fee. This fee ranges from a couple of hundred pounds to almost a thousand pounds. Some lenders charge this fee even if the application is not successfully completed. Other types of fees are also important but not always applicable. Please refer to other sections of our guide so you can have a clear idea of what your costs will be.

Administrative fees

Administrative fees are sometimes charged over the course of the mortgage. In this category we also include different types of insurance costs that are spread over the course of the mortgage. Please refer to the other sections of our guide so you can have a clear idea of what these costs are since they can have a relevant effect on the amounts you will be paying to your lender over the course of the mortgage.

Early repayment fees

Early repayment fees are very important if you wish to repay the mortgage before it's term or wish to switch lenders before the special conditions that your lender has offered expire. Early repayment fees are your lender's method of keeping you tied-in to him for longer than you would wish.

Usually these conditions are valid as long as a form of discount is in place and in some cases over the whole course of a mortgage. These fees can range from a couple of months of interest to a percentage of the outstanding capital amount. Please refer to our remortgaging specific guides for further information. It is important to know what the early repayment fees are before committing to a mortgage. Remortgaging can save you thousands or even tens of thousands of pounds providing you can switch mortgagers without severe penalty.

Exit fees

Once you have completed payments on a mortgage most lenders charge certain fees. These fees could be Deed Release Fees, Sealing Fees, Final Administration Fees or Final Redemption Fees. Please refer to our other specific guide on this subject.

Mortgage Duration

The duration of your mortgage is a period of time that you choose in which you wish to pay back the money loaned to you and the attached interest. This period of time also affects the interest rate that your lender will offer. The mortgage duration is usually between 5 and 25 years.

Main Mortgage Types

Although different types of mortgages exist based on a combination of the type of interest applied and the method of capital sum repayment we have classified mortgages by the way that the capital sum is repaid. Having a clear image of the ways in which you can payback the capital amount and the types of interest that is applied to the capital amount, and by being able to create different combinations of the two, you can have a clear idea of the full range of offers that lenders have in terms of mortgages.

In this basic guide we will give a brief description of the mainstream types of mortgages. Because each type of mortgage deservers a in-depth look we have a specific guide for each of the mainstream types of mortgages plus a overview of all existing types of mortgages. Please refer to all the guides before making a decision.

Repayment Mortgages

Repayment Mortgages are the most common type of mortgages. Each payment incorporates a part of the capital amount and the interest according to the interest rate that is valid at the time. As more and more of the capital amount is paid off the interest incorporated in each monthly payment gets smaller and smaller.

Interest-Only Mortgages

The interest-only mortgage is a system by which the borrower pays the interest on the capital amount each month and repays the capital amount at the end of the mortgage. This system is of a higher risk to the borrower because of the possibility of not being able to make such a huge payment at the end of the mortgage.

Other Types of Mortgages

Repayment Mortgages and Interest Mortgages are the two main types of mortgages if we categorize mortgages by the way in which the capital sum is paid back. The other mortgage types are just variations of the two, produced by the differences in interest and clause or, for interest-only mortgages, by the provisions for the lump sum payment at the end of the mortgage term.

Flexible Mortgages

Flexible mortgages are similar to repayment mortgages with the added benefit of being able to overpay at any time without penalty and to underpay within the amounts that you have previously overpaid.

Current Account Mortgages

Current account mortgages are flexible mortgages with even more added flexibility in the sense that they combine a current account with a mortgage. Your earning are deposited into the current/mortgage account after which the interest is applied to the remaining capital sum. When the account holder withdraws money the interest is again calculated on the increased outstanding capital sum. The account itself can have a checkbook or debit card attached to it.

ISA Mortgage

The ISA mortgage is a type of mortgage that requires that the interest on the capital amount be paid to the lender and the capital amount payment be deposited in a ISA account that can be used for investments, life insurance policies or just interest. At the end of the mortgage, the account balance is used for paying back the capital amount. The advantage of this system is that the ISA account is tax exempt for a certain amount of deposits per year.

Pension Mortgage

The pension mortgage is a type of mortgage intended for the self employed that only requires the payment of interest. The capital sum remains outstanding and is intended to be paid at the end by the pension plan. As with the ISA mortgage one of the advantages is the tax exemption opportunity.

Endowment Mortgage

This is a type of mortgage tha requires the payment of the interest directly to the lender and the installments of the capital sum into an investment plan. At the end of the mortgage the ability to pay back the capital sum is dependent on the performance of the investments fund.

Choosing a Mortgage

Choosing a mortgage is a very important step in your life as it will, most probably, occupy much of your financial resources for almost half of your life. The difference between a bad choice and a good choice may range from a couple of thousand pounds to tens of thousands of pounds in loss. Because each individual has a particular financial situation and life style we cannot decide for you.

We can, as experts in mortgages, point you in the right direction and provide complete and professional information on all aspects of mortgaging in a way that is easy to understand.

Final Word

Considering the importance of choosing a mortgage we take the view that, before choosing a mortgage, it is worth your while to become at least well informed if not an expert in mortgages.

You can use the services of a mortgage broker, but even if you do it is important that you have a knowledge base that you can use in order to understand the subject in question.

We have made every effort, in this guide and the others, to answer all your possible questions and to provide you with all the possible options that you might have in choosing a mortgage. We only hope that you will make the effort and allocate the necessary time to understand mortgaging.