It is a good idea to understand some of the important mortgage terms and calculations instead of just accepting them blindly. A good understanding of mortgage calculations will help you make the best financial decision that suits your circumstances.
Your mortgage broker will do his best to explain the terms of the loan. They are there to help you guide through the process, so consult with them regularly.
Here are some of the important terms and calculations that you will come across while applying for a loan.
The Mortgage Principal Amount
The mortgage principal is the loan amount paid by your lending bank. It is based on the purchase price of the property you are looking to buy, subtracted by any down payment that you agree to pay for the home.
Needless to say, the more expensive property you buy, the bigger your mortgage principal amount will be. The loan interest and monthly payments are based on the principal amount. You should try to keep the principal amount as low as possible to keep your monthly payments down.
Mortgage Insurance Cost
Typically, most lenders aim to offer a mortgage loan that is 80% or less of the total property value. This gives them a value-to-loan difference of 20% that acts as a cushion in case the markets fall and lowers their risk.
Some lenders would be willing to advance you a loan of even 90% to 95% of total property value. But this is quite risky and they will ask you to take on property insurance which adds a further cost for you.
Note here that the cost of insurance is borne by you, the borrower. However, if you default on the loan, the insurance provides coverage for the lender’s principal amount. It seems unfair, but it is a cost of the loan and your bank will inform you about this before you finalize the contract.
Our advice is to keep your mortgage loan less than or equal to 80% of the property value.
The Loan Duration Affects Total Interest Paid
Most borrowers get mortgage loans for 15 to 30 years. You can get a loan for a shorter period if your mortgage lender offers it.
The benefit of keeping your loan duration short is that you will have to pay a lower amount of interest in total. Consider the following example.
Suppose you take out a mortgage loan on a property for £150,000. Your interest rate is 4% and the loan lasts for 30 years. Your lender calculates monthly payments of £716 for thirty years. The total amount you will need to repay will be £257,760. The additional amount you would have paid on loan is £107,760.
Now suppose you take the same loan of £150,000 at 4% but want to repay it in 15 years instead of 30. Your monthly calculations come to £1,109 for a total of £199,620 paid back in 15 years. The total interest you would have paid equals £49,620.
Obviously, it is better to keep the loan term as short as possible to minimize your total expense. However, you will need to look at your monthly budget for this. It may be easier for you to pay £716 each month compared to £1,109.
Variable and fixed rate mortgage rates
Another important factor that determines your mortgage loan payments is the type of interest rate. Lenders offer two types of options here;
- variable interest rate that changes based on the Bank of England’s rate
- A fixed interest rate
The variable interest rate is helpful when the existing rates are too high and you expect them to go down in the future. The risk with Variable rate mortgages is the rates may remain high, or even go higher, this could make your mortgage unaffordable.
The fixed interest rate is more useful when the interest rate is low. You get your rate fixed at the current agreed level and you get fixed payments based on this rate making this the safest and most popular option.
The interest rates in the UK and much of the western world have been low for quite some time. It is advised to stick with fixed rate mortgages if you are planning to finance a home right now.
We believe that borrowers should be fully informed about various mortgage costs, calculations, and options available to them. This helps them make the right decision about getting finance for their property.
In this blog, we described some important mortgage calculations that can be useful to buyers. To find out more, please get in touch with Sterling Capital Group.