How a mortgage works
You borrow a large sum against a property. The lender takes a legal charge over it, meaning they hold a claim on it until the debt is cleared. You repay monthly over a term usually measured in decades.
On a repayment mortgage each payment covers interest plus a slice of the capital, so the balance reaches zero at the end of the term. On an interest-only mortgage the payment covers interest alone and the full capital remains outstanding at the end, to be repaid from a separate arrangement. Interest-only lowers the monthly cost and leaves a large sum to find later, so lenders generally require evidence of a credible repayment plan before offering it.
Because the term is long, amortisation is pronounced. In the early years most of each payment is interest and the balance falls slowly. That is why an overpayment made early has an outsized effect on total cost: it removes capital that would otherwise have accrued interest for decades.
Deposit and loan-to-value
Loan-to-value is the loan expressed as a percentage of the property's value, so a larger deposit means a lower LTV. It is the biggest single driver of the rate you are offered, because it sets how much of a price fall the lender absorbs before the debt exceeds the security.
Lenders price in bands rather than on a sliding scale, with thresholds at round percentages. Crossing one can move the rate meaningfully, while a larger deposit that stays inside the same band may change nothing. If you are close to a threshold, work the figure out before you apply.
If property values fall far enough that the outstanding balance exceeds the property's value, the borrower is in negative equity. It is not an immediate crisis if the payments continue, but it makes selling or remortgaging difficult, because there is no equity to carry into the next arrangement.
Fixed and variable rates
| Type | How it behaves |
|---|---|
| Fixed rate | The rate is held for an initial period agreed at the outset, so the payment is predictable. When that period ends the mortgage usually reverts to the lender's standard variable rate, which is often higher. The end of a fixed period is a decision point, not a formality. |
| Tracker | Moves with a reference rate, typically a central bank rate, plus a margin. The payment changes when the reference rate changes, up as well as down. |
| Standard variable rate | Set at the lender's discretion. It can move without a change in the reference rate. Most borrowers are on it only between deals. |
| Discounted variable | A discount off the standard variable rate for a period. The discount is fixed; the underlying rate is not, so the payment can still change. |
A fixed rate buys certainty, not a lower cost. Whether it proves cheaper depends on where rates go, which nobody can tell you in advance. The useful question is not which is cheaper but how much variation in the payment your finances can absorb.
Costs beyond the rate
The rate is only part of what a purchase costs. Budget for the following separately from the deposit: they are generally payable in cash and cannot be added to the loan.
- Arrangement or product fee — charged by the lender. A lower rate with a large fee may cost more overall on a smaller loan; the comparison depends on the amount borrowed.
- Valuation and survey — the lender's valuation protects the lender, not you. A fuller survey is a separate, optional cost that can reveal expensive defects.
- Legal fees and searches — conveyancing, local authority searches and registration.
- Transaction taxes — purchase taxes vary by jurisdiction, property value and buyer status, and can be among the largest single costs.
- Insurance — buildings insurance is normally a condition of the mortgage.
- Early repayment charge — payable if you leave a fixed or discounted deal before it ends, usually a percentage of the outstanding balance.
- Moving and immediate repairs — routinely underestimated, and due exactly when cash is tightest.
Stages of a purchase
- Work out the real budget
Deposit, plus the cash costs above, plus a reserve for the first months in the property. The maximum a lender will advance is not the same as the amount it is sensible to borrow.
- Decision in principle
An indication of what a lender might advance, based on information you supply. It is useful when making an offer, but it is not a commitment and can still be withdrawn.
- Offer and full application
Once a purchase is agreed, the full application begins: income verification, credit assessment, and a valuation of the specific property.
- Formal mortgage offer
The lender's binding offer, subject to its conditions and valid for a defined period. Read the conditions — they can require work to be completed or documents produced.
- Completion
Funds are released, the charge is registered, and the first payment date is set. From this point the obligation runs for the full term.
What can go wrong
A mortgage is secured against the property. Sustained missed payments can lead to repossession, and a repossession sale may not clear the debt, leaving a shortfall you still owe. This is the material difference between a mortgage and unsecured borrowing.
Three things cause most of the difficulty, and all three are easier to handle early:
- Payment shock at the end of a fixed period. Reverting to a standard variable rate can raise the payment sharply. Diarise the end date a few months ahead rather than letting it pass.
- Income interruption. Illness, job loss or a business downturn against a payment calculated on uninterrupted income. Lenders have forbearance processes, and contacting them early gives more options than contacting them late.
- Underestimated running costs. Maintenance, service charges and insurance are not optional and tend to arrive together.
Frequently asked questions
How much deposit do I need?
It depends on the lender, the jurisdiction and the property. Lenders price in loan-to-value bands, so the practical question is which band your deposit reaches rather than a single minimum figure.
Is it better to overpay or to save?
Compare the mortgage rate against the after-tax return available on savings, and check whether your agreement limits penalty-free overpayments. Many people keep an accessible cash reserve first, because an overpayment is difficult to reverse if you need the money back.
What happens at the end of a fixed-rate period?
The mortgage usually moves to the lender's standard variable rate unless you arrange a new deal. That rate is often higher, so the payment can rise noticeably. Reviewing options before the period ends is normal practice.
