Here’s how it works
The Interest Rate
You find a home to buy and approach a mortgage lender to provide a loan to help you. You will be looking for a mortgage with the lowest possible interest rate.
The interest rate is the most significant thing about a mortgage. Each of the mortgage lenders has its own standard variable rate (SVR) of interest. These can vary by several per cent, although most mainstream lenders will be within a couple of per cent of each other.
The lower the interest rate the less money you have to pay back over the mortgage term. (Related topic Why the interest rate and fees matter so much).
You can read full details about how to pick the best mortgage in the How to Choose your Mortgage section
The set-up fee
This can also be called an arrangement or reservation fee, and it can be anything from a couple of hundred to several thousand pounds, depending on the mortgage you choose.
To find out more about mortgage fees please see What are all these fees for?
The early redemption penalty
The lender agrees to give you the mortgage for an agreed period – aka the mortgage term.
You can actually pay off your debt any time you want, but to discourage you, the lender will probably charge an early redemption penalty if you leave before the agreed time.
For example, you may have to pay, say, 5 per cent of the all the money you still owe.
(So, if you’d got £100,000 left to pay, you’d have to cough up an extra £5,000 just so you could leave.)
Because of this, it’s generally best to avoid mortgages with an extended redemption penalty – that is, a penalty that lasts longer than any initial fixed or discounted interest deal.
You insure your home in case of fire or other disasters, and you insure the contents against damage or theft.
Your mortgage lender will also expect you to insure your life in case you die during the mortgage term, so that the loan can be paid off.
If you don’t do this and the worst happens, if your dependants can’t keep up the repayments, they could be left homeless.
You can also choose to insure your monthly mortgage payments so they will be covered if you lose your job or become too ill to work. This is called mortgage payment protection insurance – and it’s optional.
Another alternative is to take out income protection insurance. This is likely to be slightly more expensive than a mortgage protection policy, but it may give far better cover.
You can read the full section on mortgages and insurance here
You hope that the value of the property rises over the mortgage term (ie the period of the mortgage) at the end of which, the property finally becomes yours.
It usually will rise significantly because of inflation – but there is no guarantee. If it does, the amount you borrowed will seem smaller compared to its final value.
Remember though, the total amount you have paid the mortgage lender will be much more than the original cost of the property.
For example, once you take the interest into account, a £100,000 house could easily cost £250,000 to buy over 25 years.
However, the house will probably be worth £500,000 or more by then – a far better return than you would get if you put your cash in a bank or building society account.