This page explains the mechanics of the most common form of housing loan. It is general explanation of how the instrument works, and it is not advice about whether any particular borrowing is suitable for anyone. Those decisions belong with a qualified adviser who knows the individual circumstances.
The basic shape
A repayment mortgage is a loan secured against a property, repaid by a level monthly payment over an agreed term. Each payment contains two parts: interest on the outstanding balance, and a repayment of some of the capital.
The proportions change as the loan runs. Early on, when the balance is large, most of the payment is interest and the balance falls slowly. Later, as the balance shrinks, the interest portion shrinks with it and the capital repayment accelerates. This is why a mortgage feels like it is barely moving for the first several years and then appears to collapse quickly at the end.
An interest-only loan pays no capital at all during the term, so the monthly cost is lower and the full balance remains outstanding at the end, to be repaid from some other arrangement. It is a different instrument with a different risk profile, not a cheaper version of the same one.
Term, monthly cost and total cost
Lengthening the term reduces the monthly payment and increases the total interest paid, because the balance stays high for longer. Shortening it does the opposite. There is no arithmetic trick here: the same capital is being borrowed either way, and the only variables are how long it is outstanding and at what rate.
The practical consequence is that "affordable" has two meanings that can point in opposite directions. A longer term is more affordable monthly and more expensive in total.
Rate types
How the common rate types behave
- Fixed rate
- The rate is fixed for an agreed initial period. Payments are predictable during it, and the loan reverts to the lender's standard variable rate at the end unless a new deal is arranged.
- Tracker
- The rate follows a published reference rate by a set margin. Payments move when the reference rate moves, in both directions, usually promptly.
- Discounted variable
- A discount off the lender's own standard variable rate for a period. The lender can change the underlying rate, so the payment is not directly tied to any public benchmark.
- Standard variable rate
- The lender's default rate, applying when an initial deal ends. Typically the most expensive position and the one borrowers fall into by inaction.
- Offset
- Savings held with the lender are set against the balance for interest purposes, reducing interest charged while keeping the savings accessible.
The end of a fixed period is the moment that matters most and the one most easily missed. A loan that reverts silently to a standard variable rate can become substantially more expensive without anyone deciding anything.
Loan to value, and why it changes the price
Loan to value is the loan expressed as a percentage of the property's value. Lenders price in bands, and the difference between bands is often larger than the difference between lenders within a band. Crossing into a lower band, whether by a larger deposit or by capital repaid over time, generally improves the rates available.
Loan to value also determines what happens if prices fall. A large deposit is a buffer; a small one means a modest fall in value can leave the balance close to or above the property's worth, which restricts remortgaging precisely when it would be most useful.
Affordability testing
Lenders assess whether the payments are sustainable, not merely whether they are payable today. That assessment looks at income and its reliability, existing credit commitments, dependants and regular outgoings, and it usually applies a stress test: could the borrower still pay if rates were materially higher?
This is why a household can be paying more in rent than a mortgage would cost and still be declined. The test is about resilience to change, not about the current monthly comparison.
Fees, and the true cost of a deal
The headline rate is not the whole cost. Arrangement and product fees, valuation fees, legal costs, and the option of adding fees to the loan, which means paying interest on them for the rest of the term, all affect the real number. On a small loan, a large fee can outweigh a lower rate entirely; on a large one, the reverse is often true.
Early repayment charges are the other item worth understanding before rather than after. They typically apply during an initial fixed or discounted period, are expressed as a percentage of the balance, and are the reason that moving or repaying early can be expensive at exactly the wrong moment. Where a loan is portable, it may be possible to carry it to another property, subject to the lender's conditions at the time.
Insurance and protection
A lender will require buildings insurance from exchange. Beyond that, the relevant protections concern what happens to the payments if income stops, and they are individual decisions about individual circumstances rather than a standard product to be bought without thought.