An Overview Of How Mortgages Work And Their Regulation In Britain

Getting Your Foot On The Property Ladder – A Guide To Mortgages For First-Time Buyers
Chapter Two

Story Highlights:

This overview of mortgages takes you through a step-by-step guide of the most important information you need to know:

  • What a mortgage is
  • Who provides mortgages in the UK
  • Who regulates the mortgage industry in the UK
  • Decisions before applying for a mortgage – how much to borrow, saving for a deposit, researching the mortgage market
  • Different types of mortgage – Fixed-Rate and Variable-Rate (both trackers and discount)
  • Applying for a mortgage – using a mortgage broker, interviews with mortgage lenders, extra fees for mortgages
  • Finding a property to buy and putting in an offer
  • Where property ownership is registered in the UK

The essentials of UK mortgages and how they are regulated

Although mortgages are a frequent topic of conversation in the UK, how much do you really know about how the mortgage industry operates and how mortgages work?

In this chapter, we’ll be giving an overview of mortgages and answering frequently-asked questions about how they work and what you need to know before you decide to take the plunge and buy property.

What is a mortgage?

Quite simply, a mortgage is a loan. But unlike personal loans, it’s specifically tied to a piece of property so that it acts as security against the loan. If you default on your payments, then your mortgage provider has the right to take back (repossess) the property.

An image of a model house and coins on a table depicting how mortgages work and their regulation

Typically, mortgages are for a set period, usually 25 years although shorter or longer terms are also possible. Once you’ve borrowed the money, a repayment plan is set in place. Although there are different types of mortgage, the most common is that you have a monthly capital repayment plan. As well as paying back the original money you borrowed (the capital), you’ll also be charged interest on the amount you’ve borrowed.

Who provides mortgages in the UK?

Most mortgages in the UK are provided by building societies, banks, specialised mortgage corporations, insurance companies and pension funds. All in all, there are 200 different financial institutions offering mortgages in Britain although Lloyds Bank and Nationwide Building Society have the largest share of the market.

Who regulates the mortgage industry in the UK?

Although banks and building societies have always been closely regulated in the UK, the former Financial Services Authority (now the FCA) implemented a regulatory scheme specifically for mortgages as a result of the Financial Services Act of 2000.

The professional conduct of mortgage providers is regulated by the FCA

The professional conduct of mortgage providers is regulated by the FCA. There are strict rules regarding the use of unfair and misleading adverts and promotions as well as checks that the terms of any contract for financial services are fair for the consumer. Regulations were originally set out in the rules for Mortgage Conduct of Business (MCOB) but these regulations were overhauled as a result of the FCA Mortgage Market Review (MMR) in 2014.

As regards their financial conduct, deposit-taking firms in the UK come under the jurisdiction of FCA’s sister organisation, the Prudential Regulation Authority. They ensure that firms have a high enough level of capital to offset their lending risks.

If you have a complain about your mortgage provider, your first step is to take the matter up with them. If you feel it hasn’t been dealt with to your satisfaction, there’s a complaints procedure,through the FCA, which can be referred to the Financial Ombudsman Service.

Decisions before applying for a mortgage in the UK – How big a mortgage should I get

Once you’ve decided that you’d like to buy a house, the first thing you have to work out is how much money you should borrow. There’s no set figure to this since it ultimately depends on a number of factors. The first is out of your hands and that is the prices of property in the area where you live. London is without a doubt the most expensive place to buy property in the UK whilst in general terms, the South of England is pricier than the North.

You could consider starting with something smaller with the intention of trading in and moving up as you begin to pay off the original capital and as your salary increases.

The other factor to take into account is the size of the property you’d like to purchase; you could start with something smaller with the intention of trading in and moving up as you begin to pay off the original capital and as your salary increases. Alternatively, you could start with something larger with the hope that as house prices rise, your property represents an investment as well as a home.

Another factor affecting the amount you wish to borrow is whether you’d like to buy a house with someone else. If you’re involved in a serious relationship, you might see buying a house together as the next logical step. However, you don’t have to buy with your partner, many people often choose to buy their first property with a close friend. Obviously, buying with someone else has the major advantage that the price you can afford is based on two salaries rather than on just one.

Summary:

Mortgages are loans, usually of 25 years, which are secured against the purchase of property and are usually repaid in monthly instalments with added interest.

Mortgages are offered by 200 financial institutions in the UK but mainly by building societies and banks.

Both the FCA and the PRA are responsible for regulating different aspects of the mortgage industry in the UK.

The size of your mortgage depends on house prices where you live, the type of property you wish to buy and whether you’d like to buy alone or with someone else.

Saving for the deposit

Gone are the days of the housing boom when mortgage providers would offer a 100% mortgage (and in some cases 125% mortgages). You’ll be expected to contribute a sum of money towards the purchase price in the form of a deposit. It’s possible to get a 95% mortgage but ideally, you should be saving at least 10% (with the most competitive interest rates offered for deposits of 40%).

A picture of a piggy bank and coins on a table symbolising the act of saving money for a mortgage

The reason why mortgage providers wish you to have a deposit is that the larger your share of the property (or your equity), the less risk it is for them as they’re lending less money and more certain of recovering the money they lent if anything goes wrong.

A glance at property rates in your area and dividing it by ten will give you a rough idea of how much you need to save for your deposit. You should think carefully about your outgoings and ways you can cut down so that you’ll be able to save faster and more easily. It may be a struggle at first but if you’re serious about buying property, you have to keep your long-term goal in mind and remember that all the sacrifices will be worth it when you hold that front-door key in your hand.

Questions:

Who offers the most mortgages in the UK?

The vast majority of mortgages in the UK are offered by building societies and banks. Although in the 1980s, the building societies lost a lot of ground to banks in mortgage provision (dropping by nearly a third of the market share), they’ve managed to regain a lot of lost custom. The services provided by both types of financial institutions are becoming increasingly similar.

How much is the average deposit for first-time buyers?

According to a survey carried out by the consumer watch-dog ‘Which?’, the average deposit for first-time buyers was 17%.

How many mortgages are there in the UK?

According to the FCA, there are 10 million outstanding mortgages in the UK (2014 figures).

How many houses are sold every year in the UK?

The number of houses sold in the UK can vary from year to year due to various economic factors but it averages around 1 million properties.

Researching the mortgage market

It’s important to know what the different types of mortgage are so that you have a better understanding of this financial product before you start shopping around. In order to compare mortgages you should know how the product is sold/arranged and the role that the interest rate plays in how much you’ll end up paying back to your mortgage provider.

the most common types of mortgage are fixed rate and variable rate

Although there are other different types of mortgage, the most common are fixed rate and variable rate. Let’s look at these 2 different categories in more detail.

Different types of mortgage

Fixed-rate mortgages

As their name suggests, fixed-rate mortgages are set so you pay the same amount in monthly mortgage payments every single month irrespective of any changes in interest rates. This allows you to budget and you don’t have to worry about how fluctuations in bank interest rates will lead to increases in your repayments. You will be locked into this fixed rate for a specified number of years – 2, 3, 5 or even 10 years or more. During this period, you’ll be charged an exit fee (or Early Repayment Charge) if you wish to get out before the end of your fixed deal.

The main drawback of fixed-rate mortgages is that the interest rates are higher. However, you’re paying for the added peace of mind that there will be no unpleasant shocks in the future regarding your mortgage payments.

Variable-rate mortgages

There are 2 types of variable-rate mortgages: trackers and discount. Although both take into account changes in interest rates, they’re calculated in different ways.

A tracker variable-rate mortgage is directly linked to the Bank of England base rate and are expressed as a percentage above this base rate. Whenever the Bank of England changes its base rate, your interest rate will also change correspondingly so your mortgage repayments will also be affected.

There are 2 types of variable-rate mortgages: trackers and discount. Although both take into account changes in interest rates, they’re calculated in different ways.

On the other hand, a discount variable-rate mortgage is linked to your mortgage provider’s SVR (Standard Variable Rate). As this is set by your lender, this rate can change without warning and without being triggered by changes in the Bank of England’s base rate. Tracker variable-rate mortgages tend to be more popular as they’re seen as less risky.

Summary:

In order to take out a mortgage, you need to save for a deposit which should ideally be at least 10% of the property price range you’re aiming at.

The type of mortgage you take out and how the interest rate is calculated will directly affect how much you’ll pay back to your mortgage provider.

Fixed-Rate mortgages guarantee your mortgage repayments stay the same but there’s a higher interest rate in return for this security.

The repayments of variable-rate mortgages can vary according to changes in the Bank of England’s base rate or changes in interest rates set by your mortgage provider independently.

Applying for a mortgage – Using a mortgage broker

Before you approach mortgage providers and set in motion your application procedure, you must decide whether you’re going to use a mortgage broker or independent financial adviser to help you find the right mortgage for you. Although they’ll be able to cut out a lot of the legwork for you, their fee is something that will have to be added to your final costs of buying property (although some work on commission given by lenders).

How are mortgages calculated?

In the days of the property boom, mortgage providers used to judge whether you should be granted a mortgage by using your annual salary and multiplying it by a multiplier. (For example, 3 or 4 times your salary). This gave them an idea of whether you earned enough to afford the mortgage repayments. However, in light of changes in regulations making the vetting procedure stricter, they’re now more concerned about knowing about both your salary and your monthly expenses to see whether to lend you the money.

Interviews with mortgage lenders

In an initial informal meeting with a mortgage provider, they’ll need to know about your finances so you have an idea of what you can afford. In return, they’ll inform you about the types of mortgages they offer as well as details about their services and any fees.

An adult couple are signing paperwork related to their mortgage

Once you’ve chosen a mortgage provider, the interview is longer since they’ll need to know more details about your financial situation. Also, you’ll have to provide proof in the form of payslips, bills and bank statements so they can carry out a full affordability check.

If your application is accepted, you’ll receive a DIP (Decision in Principal) or AIP (Agreement in Principal) which will prove your creditworthiness and seriousness as a bidder to anyone selling property.

Now, it’s the tiring – though exciting – part as you start looking for the property you’d like to buy. Before you do, what are the other expenses associated with buying property?

Extra fees when taking out a mortgage

When you’re saving money for a deposit on your first home, it’s important that you’re aware of the extra fees and expenses you’ll need to pay. Buying property can work out to be much more expensive than you thought.

If you’ve used a mortgage broker, then you might be responsible for paying for their expertise. Apart from the fee that you’ll have to give your mortgage provider for arranging the mortgage, they’ll also levy a non-refundable booking fee. Once you’ve found a property, a survey needs to be carried out to make sure it has no major structural problems, for which you’re also liable.

To transfer the title deed into your name, you’ll be required to pay for conveyancing and legal fees since SDLT (Stamp Duty Land Tax) must also be paid when you purchase property.

You’ll also need to take into account the removal fees (if you’re moving from rented property) or the cost of buying furniture and electrical appliances (if you’ve been living with your parents). Finally, a condition of your mortgage will be that you take out building insurance so you’ll have to budget for this as well when saving for your dream home.

Questions:

How long is the term of the average mortgage?

Although the average term is 25 years, more and more people are choosing 30- or even 40-year mortgages so their monthly repayments will be less. According to the lender Halifax, 28% of the mortgages they granted in 2016 were for 30-35 years.

How much is the Stamp Duty when buying property?

The SDLT is calculated at 2% on the proportion of the property price which exceeds £125,000.

If I receive a DIP, can my mortgage lender then change their mind?

A DIP isn’t a sure-fire guarantee and they could change their mind if it’s later found that you gave misleading information on your mortgage application.

How much do I have to pay my mortgage provider as a fee?

This depends on the mortgage provider since the lowest rates for mortgages often come with the highest fees. This is something you should bear in mind when comparing the different lenders on the market but you’ll pay at least £1,000 and often much more.

Finding a property to buy

Of course which property you buy will depend on the size of the mortgage you’ve been given. Using an estate agent is the most convenient way to get an idea of what’s on the market – either in the High Street or online. Think about location. Where would you live to live? Don’t forget to estimate commuting costs if you decide to move further away from your workplace. The property might be cheaper but how much extra would it cost you a year for petrol or fares? Apart from work, bear in mind other amenities and facilities in the area.

Using an estate agent is the most convenient way to get an idea of what’s on the market – either in the High Street or online.

Have a look around a number of properties before you make your final decision. Choosing a home is such a subjective issue but think about the building itself, the size of the rooms and so on. Once you’ve found the one that you’d like, you’re ready to make the next step in buying a house which is putting in an offer.

The final step – putting in an offer

Once you put in an offer for a house and it’s been accepted, you’ve very close to achieving your goal of having your very own home. All that needs to be done now is to exchange contracts and making arrangements for the first payment of your mortgage.

Summary:

You could use a mortgage broker to find you the best mortgage but you’d have to pay their fees.

New regulations mean that mortgage providers don’t only look at your income to judge whether you can afford a mortgage but also consider your expenses.

Once you’ve received a DIP, you’re ready to start looking at properties.

There are a number of extra fees you should budget for when buying a house such as arrangement fees, Stamp Duty, legal fees and removal costs.

Once your offer has been accepted, you’re ready to exchange contracts and to start paying your monthly mortgage payments.

Where is property ownership registered in the UK?

Funded in 1862, the Land Registry is a non-ministerial government department which is responsible for safeguarding details of all land and property in England and Wales in case of dispute. (Equivalent departments are the Registers of Scotland and the Land & Property Services in Northern Ireland). Entirely funded by registration and search fees, the record of your ownership of a house will be recorded there. Although the property title will be held in your name, your lender’s interest will also be officially registered as a mortgage.


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