What Affects the Cost of Your Mortgage? - 6 Determining Factors
The idea of buying a home, whether as a first-time buyer or a homeowner looking to buy their second property, is an exciting venture and a goal that many people work hard towards achieving in their lifetime.
And while the thought of buying a house may be a thrilling investment, it is an expensive one at that, and will probably be the biggest loan you ever take out. For this reason, it pays to know the average cost of a mortgage and what factors determine the cost and that of interest rates, so that you can start putting plans in place and building up a savings pot to be financially prepared when the time comes.
In this guide to mortgage and interest rate costs, we will look at factors that have a significant impact on the cost of a mortgage and what affects and determines mortgage interest rates, an expense that has to be paid on top of your mortgage loan.
What’s the average cost of a mortgage?
According to the UK House Price Index on HM Land Registry, the current average price of a UK home is £231,185.
Of course, the cost of the home you choose completely depends on things like the area, the number of bedrooms and how much work needs doing, etc.
But when it comes to working out your average mortgage payments per month, it depends on the loan deal you get with your chosen mortgage lender, the current interest rates at the time of buying (as you have to pay interest on top of the loan), and a number of other factors, which we have listed below.
6 factors that determine the cost of your mortgage
1. Your credit report and score
When it comes to borrowing money, whether that’s a personal loan, car on finance or mortgage etc, the lender/provider will want to check your credit history before they accept your credit application, as well as other things like your income, etc.
The reason for checking this is to see how well you’ve managed your credit in the past, i.e. are you good at keeping up with monthly payments on time and in full?
If you have a 'good' to 'excellent' score, it is very likely that you’ll be accepted for credit, so it is always a good idea to keep a check on your credit score and work on improving it and building it up before you look to take out loans and borrow substantial amounts of money.
If you do not keep up with payments, your score will drop and make it more difficult for you to get credit in the future, and it is likely that you’ll be offered higher interest rates compared to those who have a positive credit rating.
So if you really want to lower the cost and get the best deal when getting a mortgage, it is worth improving your score as much as possible.
Read our Complete Guide to Credit Scores for more information.
2. The LTV (loan-to-value) ratio and deposit
An LTV ratio is the difference between the amount of your loan (i.e. the amount you’re borrowing and paying back over time) and the amount you’re paying yourself - the deposit.
For example, you want to purchase a house costing £180,000 and have a total of £20,000 in savings to pay as a deposit, so you will need a loan of £160,000.
In this instance, your LTV ratio is 88.89% (as £160,000 is 88.89% of £180,000) and your deposit covers the remaining 11.11% (£20,000). To work out the LTV ratio for your own situation, a mortgage LTV calculator can help.
Generally, if you borrow an amount of money that represents a high loan-to-value ratio (meaning you’re paying a lower deposit), your monthly payments are likely to be higher than if you were to have a lower LTV and pay a larger deposit.
Putting down a bigger deposit (and therefore having a lower LTV) means that you’re likely to pay less in interest every month and therefore, over the whole term, too.
3. Market interest rates: Fixed vs variable
When looking for the best mortgage deal, the interest rate is a very important factor in determining the overall cost.
It is hard to give one ‘average mortgage interest rate’, as there are different types of mortgages and interest rates available in the UK; you can either choose a mortgage deal that has a fixed or variable interest rate. Here’s the difference between the two:
What is a fixed interest rate?
Fixed interest rates are set for a certain length of time and do not change within that period. The benefit of this is that you always know where you stand when it comes to your monthly payments, no matter what’s going on in the interest rate market.
A fixed rate mortgage usually lasts for the first two years of buying your home, but it can be more in many cases depending on your deal (see examples below, and each monthly payment is fixed and stays the same throughout that term.
When this period finishes, you either stay with your lender and move onto a higher standard variable rate (SVR) with them, or you re-mortgage with another lender who has a better offer. This is where a mortgage broker comes in very handy.
What is a variable interest rate?
As opposed to ‘fixed’, the term ‘variable’ means that interest rates are likely to fluctuate, usually due to the constant changes that occur in the UK's economy.
During times of inflation when the economy is booming, interest rates tend to increase, mainly to encourage people to save their money, rather than spend, and to make borrowing more expensive. On the contrary, when the economy is not doing so well, interest rates are usually cut to encourage people to spend their cash again.
There are three different types of mortgage variable interest rates:
- Standard variable rate mortgages (SVRs): Every lender has an SVR that they can change whenever they want - it usually follows the Bank of England’s (BoE) base rate movements.
- Tracker mortgages: The interest rate tracks a fixed economic indicator, which is generally in-line with the BoE’s base borrowing rate.
- Discount rate mortgages: Some lenders offer a discount on their standard variable rate (SVR) - but be careful to check whether a 3% discount means 3% off their SVR or if it’s the interest rate that you have to pay back.
According to Statista, these were the average interest rates for mortgages in the UK in December 2019:
- 2-year fixed rate mortgages: 1.45%
- 3-year fixed mortgage: 1.56%
- 5-year fixed mortgage: 1.69%
- 10-year fixed: 2.53%
- 2-year variable: 1.94%
As you can see, the type of mortgage and interest rate you choose is a big determining factor in the overall amount you have to pay back and how much your monthly payments will be. You will need to do a mortgage comparison and compare different interest rates to see which lenders are offering the best deals.
4. Choice of mortgage lender
Another factor that largely affects the cost of your mortgage is the company you choose to take out a mortgage loan with.
Most lenders are constantly analysing and evaluating the market in order to set new interest rates and compete with other lenders so that they can offer better deals. For this reason, it is important that you shop around and compare mortgage deals to get an idea of the better, more affordable deals and interest rates.
One way of doing this is by speaking to a good mortgage broker, who will do all the hard work for you by scouring all the mortgage providers and finding the best deal and interest rate based on your personal, financial situation.
5. The mortgage term
Due to the fact that you are borrowing a very large amount of money to own a house, repayments are often spread out over 25 years in most cases, perhaps up to 30 in others.
Many people, however, may want to pay it off sooner than 25 years, so may opt for a shorter term, but generally, people prefer to have a longer mortgage term as this helps lower mortgage payments and the shorter your term, the higher they will be.
While making your mortgage payments cheaper, having a longer term to pay it off usually results in you paying more interest overall, but many people don’t mind this given the cheaper monthly payments.
6. Mortgage fees
Mortgage lenders usually include certain fees in the annual interest calculation, otherwise known as the Annual Percentage Rate of Charge (APRC).
- Arrangement fee: between £0 and £2,000
- Booking fee: from £99 to £250
- Valuation fee: between £150 and £1,500
- Telegraphic transfer fee: usually between £25 and £50
- Mortgage account fee: £100 to £300
- Mortgage broker/advice fee: usually around £500
- Own building insurance fee: this is for the lender to check you have taken out a buildings insurance policy, usually costing between £25 and £50
There may be other fees included, depending on your lender, so be sure you understand exactly what you are paying for.
If you miss payments, you may also be charged for this, depending on your lender’s terms and conditions.
Other things that you will have to pay for on top of the mortgage include:
- Buildings insurance
- Contents insurance (optional, but highly recommended)
- Stamp duty (you do not have to pay this if your property costs less than £180,000)
- Solicitor fees
- Survey fees
Overall, there is a lot to consider when calculating the cost of buying a new home and getting a mortgage.
It is a good idea to make a list of everything you’ll need to pay, so that you have a rough idea of how much to put away in savings. This will help a lot when it comes to getting a new property.
Buildings insurance with Bobatoo
If you’re looking to get a new home soon, or if you’re in the process of buying one, you will need to start looking at quotes and comparing deals.
Many people choose to get a combined buildings and contents insurance policy to have the peace of mind knowing that their home and belongings are all financially covered if something were to go wrong.
Find out more about the insurance policies in our guide: What’s the Difference Between Building and Contents Insurance?
Or get a home insurance quote with us today by tapping the green button below!