A Jargon-Free Guide to Mortgages
Despite a couple of cheeky high-altitude gins, my plane journey was starting to feel endless. Paper-based, two player hangman had been the only entertainment for a while and I was reaching the limits of my vocabulary, when I managed to dredge up what I thought would be an absolute winner of a word. After what seemed like an age of my poor friend randomly guessing letters, she’d filled in ‘_ n e n c _ m _ e r e d’ and was staring blankly at the sheet of paper, looking more than a little frustrated. It suddenly dawned on me that if I thought back to just two years ago before my property investment education, I almost certainly hadn’t heard of this word, let alone knew what it meant. I realised I might have gone a little too niche. Eventually, she gave up. “By any chance do you know what unencumbered means?” I ventured. Her face of mixed annoyance and disappointment told me she definitely didn’t. I decided not to count that one as a point for me. Who says landlords are greedy?!
After that, I really started to notice how much I took my knowledge and confidence in mortgages for granted. Many of my friends and clients have very little understanding of mortgages and how they work. As we all approach an age where responsibilities and adulthood are getting harder to avoid, it is affecting some people's confidence to even try to buy a house. So, to try to de-mystify the process of house purchases just slightly, I’ve created this guide to mortgages with as little jargon as possible. Go make a cup of tea, get yourself comfy and settle in while I try to put it all into plain English. Enjoy!
Mortgages are an integral part of buying a house for most people, at least they are for those of us who start without access to bulging bank accounts! They are also an excellent way to make your money go further as a BTL (Buy-to-Let) or HMO (Houses of multiple occupancy) investor, so that you can leverage what money you do have (either of your own or from other finance) to get the maximum rental income. However, it always surprises me how little we learn about mortgages while growing up. To be honest, we get virtually no financial education at all at school, but that’s a topic for another day (read “Rich Dad Poor Dad” by Robert Kiyosaki if you want to know more). Most of us reach our mid-to-late twenties, decide we should probably start thinking about getting on the housing ladder and then are suddenly hit by a barrage of jargon stemming from one word; mortgages.
The first task for many of us is to pluck up the courage and ask someone to clarify exactly what a “mortgage” actually is. Luckily for you, I’m not even going to make you ask – a mortgage is a loan. The big difference between a regular bank loan (e.g. for a car or a holiday) and a mortgage is that a mortgage is linked to a specific property. The loan amount will get recorded as a charge on the title deeds (official documents detailing who owns the property) so that if the property is sold, the money which has been borrowed is returned to the lender before anything left over is sent to you. If you fail to make your monthly payments towards the mortgage, the lender is able to seize the property linked to the mortgage so that they can sell it and get their money back. Whereas, if you fail to make your payments on a regular bank loan, the bank won’t automatically try to seize your car or whatever else you bought with the money, they will just keep chasing you for the funds.
Sounds simple enough, but then they’ve come up with an extra onslaught of terminology, which I can only assume has been designed to make us mere mortals remain perplexed, allowing lenders to hide all manner of fees without most people realising. But you aren’t most people. If, like me, you would far rather know what banks and lenders are talking about so you can’t be caught out so easily, you need to understand what all their special words actually mean. So, for anyone who is currently a bit baffled by the terms LTV, draw-down, unencumbered and all the countless extra charges associated with mortgages, this is for you.
Yes, this one is simple – they are the ones lending the money. I tend to use the words “bank” and “lender” interchangeably as essentially, they are the same thing. However, a lot of people assume the only lenders out there are high street banks (e.g. Natwest, HSBC, Nationwide…), but that just isn’t the case. There are a plethora of other lenders who you never really hear about unless you ask a mortgage broker. Some examples would be; Paragon, The Mortgage Works, Aldermore, Kent Reliance… the list goes on. It’s often worth investigating what these other lenders can offer you as sometimes they have much better deals available than the high street banks.
I’d love to say these are little people living under the skirting boards, but actually it’s just you; the one(s) who would like to borrow the money.
These are middle men, or women, who sit between the lender and the borrower to get everything all set up. Mortgage brokers vary from big corporations to independents and have access to a range of lenders and deals depending on who they are affiliated to. They can claim they have access to the “whole of the market” even when the selection of lenders who they work with is relatively small, so make sure you do your homework. Some mortgage lenders (e.g. The Mortgage Works) won’t deal with borrowers (i.e. you) directly when setting up a mortgage, so you have to go through a mortgage broker. Mortgage brokers get paid by either the lender, the borrower or by both. If you do pay for a mortgage broker yourself, they are likely to end up saving you money in the long run, so it could still be worth it. (For more information on mortgage brokers, have a read of this useful article by Clear Score https://www.clearscore.com/mortgages/guide-to-mortgage-brokers)
Equity is the amount of a property you own outright. If you have a property worth £100,000 and you don’t have a mortgage or any other borrowing linked to it, then your equity in that property will be £100,000.
An unencumbered property is one which doesn’t already have any lending or mortgages linked to it. You can encumber a property by taking out a mortgage or some lending linked to it which as I mentioned earlier, would be recorded as a charge on the title deeds. If your property is unencumbered and you sell it, all of the money goes straight to you.
Stick with me, if you haven’t got unencumbered confused with cucumber by now, you are doing well (and you are welcome to use it as a lethal blow in any game of hangman).
LTV means “loan to value”. In everyday language, that means the amount of money the bank will lend you versus the overall value of the property. For example, if your property is valued at £100,000 and you are taking out a 75% LTV mortgage, the amount the bank will lend you is 75% of £100,000, which is £75,000. This leaves you with £25,000 equity.
Draw-down or Loan Capital
A mortgage draw-down or loan capital, is the amount of money you borrow from the lender. In the example above, the draw-down would be £75,000.
The term is how long you agree you will borrow the money for. The standard for most lenders is 25 years, but you can get longer or shorter depending on your age and circumstances.
A fixed rate mortgage freezes the interest rate for a certain period of time at the beginning of a mortgage. You generally get 2, 3 or 5 year fixed rate mortgages and they are great if you want to know exactly what your monthly payments will be during the length of time you have fixed the rate for.
A tracker mortgage is where the interest rate can change, usually depending on what the interest rate of the Bank of England does. If the Bank of England interest rate goes up by 0.5%, so will the mortgage rate. Tracker mortgages often have slightly lower interest rates than fixed rate products, but as they are subject to change, your monthly payments can go up or down depending on the economy.
An interest only mortgage is one where you just pay the interest each month, so that at the end of the mortgage you still owe the amount you borrowed in the first place. In the earlier example, this would mean you would still owe £75,000 at the end of the mortgage term (normally 25 years), so you would need to either sell the property, or take out a new mortgage to pay the lender back.
If you opt for a repayment mortgage, then your monthly payments will include an amount which goes towards the loan capital you borrowed. This is great in theory, as at the end of the mortgage term, you will have paid back the whole loan capital and you won’t owe anything. However, it does make the monthly payments significantly higher which isn’t always the best use of your money as an investor.
Interest Rate (sometimes called Product Rate)
I realise you are probably familiar with the idea of interest, but just in case, interest is the name for an ongoing fee that a lender will charge you for having borrowed their money. Interest rates are displayed as yearly percentages of the total size of the loan. So, taking our £75,000 we have just drawn-down in the earlier example, if the interest rate is 3%, you will pay 3% of £75,000 over the course of one year, which is £2,250. You normally pay this in monthly instalments, so dividing £2,250 by 12, you would pay £187.50 of interest each month.
If you have finally waded through all of the paperwork and actually take out the mortgage, some lenders will charge you a completion fee. This is often around £1000 and added onto the loan capital which you borrowed, meaning it doesn’t come out of your pocket straight away. It’s a particularly sneaky fee which can go unnoticed until you want to re-mortgage or sell the property and suddenly have to pay it back.
Redemption Penalties (or Exit Fees)
When you take out a mortgage, the lender is banking on (excuse the pun) you holding that mortgage for a significant period of time so that they will get a good chunk of money off you in the form of interest payments. So, to discourage you from paying the loan back early, they can charge you a fee. The exit fees are normally structured so that they are a percentage of the amount you are paying off and are higher the earlier you try to pay any loan capital back. For example, if you wanted to pay back £5,000 of your mortgage, you might be charged 5% (£250) if you paid it back during the first year, but only 3% (£150) if you paid it back during the third year and 0% (£0…obviously) if you paid it back in the sixth year.
There are some key professionals involved in getting a mortgage set up – brokers, surveyors and solicitors. We’ve already covered mortgage brokers, but surveyors are needed to value the property on behalf of the lender and solicitors are in charge of the legal paperwork side of the transaction. Sometimes, mortgage lenders offer incentives where they will pay for the surveyor and/or the solicitor, but if not, you can expect to pay £300-500 for a surveyor to do a valuation and £500-£700 for a solicitor. Mortgage brokers are also sometimes paid by the lender, but a decent one who is acting on your behalf is likely to cost you around £500.
Additional or Other Fees
The final fees are really just the lenders chance to make up a fee purely for their own enjoyment. Sometimes there are no additional fees, but it’s worth keeping your eyes peeled and double checking with your broker if you have one. I have known some sly “Administration” fees of up to £500!
I hope you’ve managed to stay awake throughout all of this and now feel a little more confident in mortgages and how they are structured. If you have any questions for me or feel like you would like a bit of extra guidance, please feel free to pop me a message at firstname.lastname@example.org.