Considerations for the mortgage borrower

Let’s take a look at the two main considerations for a mortgage borrower, once they have their deposit in place.

When you are thinking about taking out finance of any kind you will want to know two main things:

1. How much will it cost me on a regular basis and in total?
2. How long will I be paying the debt for?

These two elements go hand in hand and are very important for mortgages.

Interest rates

For a bank or any other lender to make money, they charge interest. Another way to look at this is to think of it as the price you have to pay for the use of the money you have borrowed. Or it is the price that the lender wants to be paid for giving you access to their money.

The higher the interest, the higher the monthly repayments – the lower the interest, the lower the monthly repayments.

Interest rates can change many times throughout the year. Lenders decide on the interest rates they want to charge based on two things:

• on an interest rate set by the central bank of the country in which they are based (this is known as the base rate in the UK); and
• the rate of inflation (which is a measure of how the price of the everyday things we buy changes over time).

It is important to link this back to mortgages. If interest rates go up then the cost of a mortgage will increase. This may in turn push house prices down as less and less people will be encouraged to take out a mortgage and buy a property.

Term

This is how long you will repay the mortgage for. Depending on the type of mortgage at the end of this period you should have paid off the loan. A typical term in the UK is 25 years.

Note: most mortgages these days are capital and interest, where each payment made clears both the interest and some of the capital. There is another type of mortgage where only the interest is paid monthly, leaving the capital outstanding until the end of the mortgage term, when it has to be paid in full. The borrower will set up an investment which they hope will meet the full amount by the end of the mortgage term.

The term of the mortgage has a direct influence on the size of the repayments: the longer the term the lower the repayments, because the mortgage amount is spread over a longer period. The opposite is true for shorter periods.

The monthly mortgage repayment will be set with reference to the term and the interest rate.

Affordability

What the interest rate and the term both help assess is affordability. This is one of the most crucial aspects within the mortgage world. However, it is one that is relatively simple to explain.

First you consider someone’s income and then look at how much they spend on a monthly basis (their expenditure). The amount left over is essentially what they can afford to spend on paying the mortgage debt and the other household costs, such as insurance, local tax, bills (for electricity for instance) etc.

Imagine that you are renting your home and now want to buy your first property. You earn £24,000 a year after taxes. This equates to £2,000 a month (per month – pm). Let’s imagine that all of your current bills and regularly outgoings come to £1,200 each month.

£2,000pm minus £1,200pm = £800pm of disposable income that could be used to make the mortgage payment and pay the additional housing costs that come with owning your own home.

In this example, when looking at your mortgage options, as long as the monthly mortgage repayment is less than £800pm (usually by a percentage set by the lender) then the mortgage should be affordable to you.