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Fundamentals of Homebuying in the UK Real Estate Market
Buying a house is one of the most expensive purchases, which is also the longest debt obligation most people have. To afford a home, buyers typically take a mortgage from banks and other lending institutions. For this reason, it’s imperative to understand how mortgages work in order to prepare your finances.
Depending on where you plan to live, you must have knowledge of the mortgage market. In the United States, consumers must satisfy certain mortgage requirements such as a good credit score, annual income, and debt-to-income ratio to name a few. Most homebuyers in America typically obtain a conventional fixed-rate loan with a 30-year term.
But in other cases, some people plan to live in another country, such as the United Kingdom. In this guide, we’ll cover the basics of UK mortgages and how they compare to home loans in the US. We’ll go over UK mortgage requirements, the typical loan term, and payment structures. We’ll also discuss common types of UK mortgages and assistance programs buyers can choose from. The guide will also include a section on what happens to your mortgage during the repossession process.
Applying for Home Loans in the UK
Lenders in the UK perform the necessary financial evaluation before granting mortgages to borrowers. You can obtain home loans from traditional lending institutions such as banks, or other sources such as building societies (that function much like credit unions in the US).
Like in the US, expect lenders to assess your employment status, salary, and additional income you may receive from work bonuses, investments, or benefits. They also check your bills and other outstanding debt obligations such as credit card payments. They perform these reviews to ensure you have enough income to make consistent mortgage payments.
Furthermore, once you file a formal mortgage application, lenders check your financial records with a credit reference agency (CRA). The three main CRAs in the UK are Experian, Equifax, and TransUnion. Prior to applying for a mortgage, UK homebuyers usually request for a copy of their credit report to know if they have a good chance of securing a loan. Similar to the US, a high credit score means you’re likely to get approved for a mortgage.
Credit rating classifications vary per CRA. According to Help & Advice, a credit score of 600 with Equifax and TransUnion puts you at a fair or good rating to apply for a mortgage. However, with Experian, which is the largest credit reference agency in the UK, scores between 561 to 720 are considered poor or low.
UK Experian credit scores range from 0 to 999, with ratings between 881 to 960 considered good. Meanwhile, UK Equifax credit scores range from 0 to 700, with scores from 420 to 465 accepted as good. On the other hand, UK TransUnion credit scores range from 0 to 710, with ratings between 604 to 627 considered good.
The chart below shows what credit score ratings are fair, good, and excellent according to the top three CRAs:
|Fair||721 – 880||380 – 419||566 – 603|
|Good||881 – 960||420 – 465||604 – 627|
|Excellent||961 – 999||466 – 700||628 – 710|
Chart from Barclaycard.co.uk
Lenders evaluate your financial history by checking previous debts, how large your debts were, and if you pay on time. This helps them assess if you’re a more creditworthy or risky borrower. The amount of down payment or deposit you pay will also determine how much a lender is willing to loan.
To process your mortgage, homebuyers in the UK are required to submit the following documents:
- P60 form from employer
- Driver’s license or passport
- Payslips (from the last three months)
- Utility bills
- Bank statements from accounts (from the last 6 months to 3 years)
- State from an accountant covering 2 to 3 years of your accounts (if self-employed)
- SA302 tax return form if you have income from more than one source or if self-employed
*Self-employed homebuyers must provide supplementary proof of income from other bank accounts to support their SA302 form
Foreigners Buying Houses in the UK
Non-residents and foreigners are allowed to obtain a mortgage in the UK. The UK government generally imposes the same property taxes for foreigners as with UK residents. On the other hand, you must work with a UK solicitor to arrange legal documents for the sale. Furthermore, you cannot secure a mortgage if you have less than two years of residency in the UK. And if you’re unemployed, expect stricter qualifications which also require a larger down payment referred to as the deposit. Note that foreigners who secure UK mortgages are also usually assigned higher rates.
How UK Mortgages Work
In the UK, the money you borrow is called the capital (otherwise known as the principal in the US market). The most popular mortgage type for first-time homebuyers is the fixed-rate mortgage. However, note that this is not the same fixed-rate loan found in the US market, which maintains the same rate for the entire loan duration. In the UK, fixed-rate mortgages only come with a fixed interest rate during the initial deal period. This payment structure is similar to hybrid adjustable-rate mortgages (ARM) such as 5/1 or 10/ ARMs in the US.
For UK fixed-rate mortgages, the initial period usually lasts for 2 or 5 years, with other homebuyers taking as long as 10 years. Most mortgages in the UK are paid over a 25-year term. This is shorter compared to the most popular mortgage in the US, which is the 30-year fixed-rate loan. On the other hand, UK mortgages are also available in 15, 30-year terms, as well as 40-year terms.
For example, if you get a fixed rate mortgage with a 5 year initial period, your rate is guaranteed to stay the same for the first 5 years. During the introductory period, you need not worry about increasing payments. The certainty of fixed payments makes them attractive to first-time homebuyers and consumers with limited funds. However, once the initial period is completed, your mortgage reverts to the lender’s standard variable rate (SVR). After the initial period, borrowers have the option to switch lenders or apply for another fixed-rate term with their current lender.
But once the mortgage reverts to SVR, the interest rate can increase or decrease depending on the UK economy and changes in the Bank of England (BoE) base rate. Likewise, your mortgage payments will be higher if market rates increase. Note that SVR rates vary per lender, depending on their own criteria. Lenders can also change their SVR any time, especially if there’s news that the BoE base rate will increase in the future.
Most mortgages in the UK are repayment mortgages, which means your payments are applied to both the interest charged and the capital (the amount of money your borrowed). By the maturity of the term, as long as you pay on time, you will have paid the full amount on your mortgage.
The Required Mortgage Deposit in the UK
In recent years, the minimum required deposit for UK home buyers is 5% of the property’s value. However, if you want to secure a more favorable mortgage rate, financial advisers recommended saving at least 15% of your home’s price. For non-residents or foreigners, the required deposit is typically higher. But the larger your deposit, the lower your interest rate and monthly mortgage payments. Consider this to maximize your overall savings. For example, if a home costs £200,000, a 5% deposit costs £10,000. Meanwhile, a 15% deposit would cost £30,000.
However, during the COVID-19 crisis, BBC reported that the minimum deposit required by lenders rose to 15% in August 2020. The large increase made it difficult for first-time homebuyers to secure a mortgage deal. It left families scouring for extra funds to cover the steep down payment. Though lockdowns have encouraged more savings, many haven’t saved enough to afford the deposit. Thus, it’s best to try to save at least 15% down on your home.
What is a Stamp Duty in the UK?
Stamp Duty Land Tax (SDLT) is a charge you must pay if you purchase land or property over a certain price. Across the UK stamp duty holidays were put in place to offset the COVID-19 crisis, though they are due to expire after the first quarter of 2021.
By April 1, 2021, stamp duty should revert to the prior threshold for all residential property purchases more than $125,000 with rates between 2% to 12%. Meanwhile, it’s 3% to 13% for second homes or buy-to-let homes that are rented out. Prior to April 1, 2021, the stamp duty floor for residential properties was set at $500,000 to help offset the COVID-19 crisis. Many policies are harmonized across countries, though some are different and terminology chages over time. In April 2018, the Welsh Revenue Authority replaced SDLT with Land Transaction Tax (LTT).
Please visit the official England, Scotland, Wales or Northern Ireland link for specific rates by country and loan scenario as each country has slightly different rules, limits, and rates with features varying for first-time buyers, landlords, and other types of buyers. Rates can also vary depending on the property use type. Non-residential property may have a different rate schedule than residential property..
UK Consumers Struggle to Afford Homes
In the past two decades, increasing home prices have made it more challenging for first-time buyers to own a home. The Institute of Fiscal Studies reported that in 2016, 27% of adults from ages 25 to 34 earning between £22,200 and £30,600 annually could afford a home. Compared to 20 years ago, the home ownership rate for this age bracket was at 65%. Growing house prices have made it more challenging for middle income young adults to buy property.
According the Resolution Foundation’s Housing Outlook Q3 2020, around 52.8% of UK families own their home. This figure is lower compared to data from TradingEconomics.com, which projected that homeownership rates could reach around 62% by the end of 2020. The global recession caused by the COVID-19 crisis affected consumers’ ability to purchase property. Though house prices tumbled, so did people’s incomes. Stricter credit restrictions are also a limiting factor for UK homebuyers.
What’s the Average Price of a House in the UK?
As of October 2020, the UK House Price Index reported that the average house price was £245,443, which was around $335,000 (USD). Property prices rose by 0.7% compared to the previous month and increased by 5.4% compared to the previous year.
Insurance for Mortgage Payments
Mortgage obligations take a significant portion of people’s income. And in the event of emergencies, such as accidents or sickness, people usually struggle to make mortgage payments. For this reason, homeowners in the UK are obliged to obtain insurance protection in case they are unable to work and pay their loans.
Mortgage insurance comes in two main types in the UK:
Payment Protection Insurance (PPI)
PPI is a kind of short-term income protection that is commonly sold with loan products such as mortgages (as well as credit cards and personal loans). This insurance covers your mortgage payment if you cannot work due to an illness, injury, and disability. It also applies if you’ve lost your job due to redundancy. But note that it has an initial exclusion period of 90 days after you stop working. This means you must be able to cover this period before you can make any claim. PPI typically covers payments for up to 12 months. After this period, you must find other means to repay your mortgage to avoid defaulting on your loan.
Mortgage Payment Protection Insurance (MPPI)
MPPI functions as a safety net that covers mortgage payments in case of unexpected circumstances. In the event of an illness, serious injury, or job loss due to redundancy, MPPI can prevent you from defaulting on your mortgage. The insurance provider shoulders 125% of your mortgage, which allows you to cover 12 months up to 2 years of payments, depending on your policy. This offers longer coverage in case you need more time to find a stable source of income. MPPI differs from PPI because the payments are given directly to you instead of the lender. An exclusion period between 30 to 60 days is needed for the policy to be in place before you can claim.
Types of Mortgages in the UK
The UK has a competitive and a well-developed mortgage market. They offer a wide variety of mortgage products to consumers with specific needs. Here’s a rundown of different mortgages available in the UK:
Tracker mortgages, unlike SVRs, follow or ‘track’ the Bank of England (BoE) base rate. Once the initial period is through, your mortgage’s interest rate moves up or down at a fixed level above the BoE. For example, you have a BoE + 3% rate. If the BoE is 0.1%, this means you will be charged 3% higher than the BoE, which is 3.1%. In the BoE monetary policy committee on December 17, 2020, members unanimously voted to maintain a base rate of 0.1%.
Take note, however, that lenders impose specifications for the lower end of the base rate. Lenders may insist that the rate cannot decrease below a certain level regardless of the current BoE, while specifying no caps for the upper end. Lenders earn a basic profit margin, but borrowers risk having increasing payments that may become unaffordable.
Discount Rate Mortgage
A discount mortgage, also referred to as a discounted variable rate mortgage, comes with an interest rate set at a certain amount below the lender’s standard variable rate (SVR). For example, if your lender’s SVR is 4.2% and your mortgage came with a 1.5% discount, your rate will be set at 2.7%. This can be placed for an initial period (such 2 or 5 years) or set for the entire duration of the mortgage. But generally, a discount mortgage is usually offered for a short period.
Discount mortgages can also be stepped. This means you can pay a certain rate for a couple of months during the initial period, and a higher rate for the remaining years of the initial period. This type of mortgage can also be capped, which means they can’t go above a certain rate. But since SVR can change at any time, increasing SVR can offset the purpose of a discount. For this reason, discount mortgages are a good option when SVR rates are stable.
Capped Rate Mortgage
A capped rate mortgage is a type of variable rate loan that cannot increase beyond a specified rate. Since the rate is capped, it keeps your mortgage payments within an affordable range. The upper limit on the rate ensures you’re never charged more than the cap amount. This type of mortgage is commonly offered as SVR or a tracker mortgage.
While capped rate mortgages ensure manageable payments, many lenders include a collar on their deals. A collar is a type of cap that keeps your rate from dropping below a specified rate. Though you’re protected from higher rates, the collar will prevent your rate from significantly decreasing. This means you’ll miss out on potential savings when rates substantially drop. Capped rate mortgages are a good fit for consumers who want protection from rising rates but are willing to give up savings when mortgage rates fall.
100 Percent Mortgage
A 100 percent mortgage allows borrowers to obtain a loan for the entire property’s cost without a deposit. This is usually geared towards first-time homebuyers who are short on funds. While it may sound attractive, this type of loan typically comes with a high interest rate compared to loans that require a deposit.
This is also a type of guarantor mortgage designed to help buyers who can’t afford a mortgage on their own. Besides the borrower, their parent or a close family member commits to taking some responsibility for the mortgage. And because the lender is financing 100% of the loan, they also request for collateral such as bonds or stocks to secure the mortgage. Some lenders may allow you to use your parent’s collateral in place of a deposit.
When you apply for a cashback mortgage, a lender offers a one-time lump sum payment to the homebuyer. They also specify the amount you will receive. Depending on your lender, you may receive your cashback after making your first mortgage payment. Meanwhile, others might hand it to you upon completion of the mortgage. Generally, UK cashback mortgage offers range between £200 and £1,000.
However, make sure to read the fine print before you take this deal. It might seem enticing, but the higher the cashback, the higher the interest rate will be for the entire term. For example, a cashback of £250 has an interest rate of 2%. If you opt for a cashback of £1,000, this can increase your mortgage rate to 2.5%. A half point rate increase means higher mortgage payments and interest charges. Over a 25-year period, it can cost you tens and thousands of pounds. This is a bad deal in the long run.
An interest-only mortgage allows you to pay the interest charged each month on your loan. You need not pay for the capital, which means it does not pay down the amount you borrowed. With only interest payments, your monthly mortgage is cheaper compared to a repayment mortgage. But at the end of the mortgage term, you must pay the full capital amount in a lump sum.
With this type of loan, while monthly payments are lower, your payments do not reduce your debt. This makes interest-only mortgages risky because they require borrowers to save a large sum of money to cover the full debt. Thus, this type of loan is most suitable for consumers with high-income and a reliable payment plan. UK lenders have strict lending qualifications on salary requirements and loan-to-value ratios before granting interest-only mortgages.
Buy-to-let mortgages are geared toward prospective landlords who want to purchase property to rent out. Since this type of mortgage lets you buy income-generating property, they typically come with higher interest rates and fees. The required deposit is also significantly larger, which is usually 25%. But depending on the lender and the type of property, the deposit can be 20% or as high as 40%. Buy-to-let mortgages are mostly paid off with an interest-only payment structure.
Most buy-to-let mortgage lending is not regulated by the Financial Conduct Authority (FCA), which aims to help consumers obtain a fair deal. However, this comes with an exception. If you wish to rent your property to a family member such as your child, parent, or sibling, your buy-to-let mortgage is evaluated according to the same stringent financial standards as residential mortgages.
UK Mortgage Assistance Programs
The UK government provides support programs for consumers who need help in purchasing homes. They offer grants and financial assistance for deposits. If you’re a first-time homebuyer with limited cash, there are government schemes that can work for you. Some of these programs include the following:
- Help to Buy Equity Loan: This program is geared towards first-time buyers to help finance the purchase of a newly built home. It allows you to borrow 5% to a 20% (40% in London) of the home’s full market value. However, you’re required to make a 5% cash deposit and get a mortgage to cover 75% of your debt. You do not have to pay interest on the equity loan for the first 5 years. But you can repay all or part of your equity loan any time. As a requirement, the house must be bought from a builder registered under the program.
- Help to Buy Shared Ownership: The shared ownership program helps you buy a share of your home and pay rent until the entire mortgage is paid off. It allows you to purchase between 25% to 75% of your home’s market value. To qualify, you must be a first-time homebuyer, or you used to own a house but have limited funds to buy one now. It’s also open to existing shared owners looking to move. Applicant’s must have a household income of £80,000 annually or less outside of London, or an income of £90,000 annually or less in London.
- Forces Help to Buy (FHTB): This allows military personnel borrow up to half of their annual salary in advance, which is a maximum of £25,000 to purchase property. The loan is free of interest and is typically used to cover the deposit and other fees. Applying members should have more than 6 months of active service and must meet medical requirements. The FHTB was mainly designed for first-time homebuyers, and those who need to move as a result of extenuating medical or family circumstances.
UK Mortgages During Bankruptcy
Now and then, when faced with financial struggles, you might have trouble making timely mortgage payments. When this happens, you’ll be charged late fees when your account is in arrears, making it harder to get by. Being in arrears in the UK means you’ve missed one or more monthly payments on your loan. Such is the case if you’re on the verge of bankruptcy. If you fail to sustain mortgage payments, your home might be repossessed by the lender.
Here’s what happens under the UK repossession process:
1. The lender contacts you about arrears. During the repossession process, your lender gets in touch about your mortgage arrears. They will ask you to explain how you plan to pay missed payments. You may propose an arrears repayment plan and have an agreement with your lender. However, if you’ve decided you cannot afford the mortgage, you can ask your lender for time to sell your home.
2. The lender starts court action. If you don’t settle your mortgage payments and you can’t agree on a payment plan, your lender may apply for the court. This is called a possession action. Under this process, the lender will provide you with a list of missed payments, the total level of arrears, and the outstanding balance on your mortgage before they go to court. It’s best to obtain legal advice once your lender prompts a court notice.
3. You’ll receive documents from the court. Make sure to keep a record of all court files sent to you. These include claim and defence forms, which is a record that your lender has applied for a repossession order. Meanwhile, a notice of review is a set review date for your case. Next, a reactivation notice states your lender has applied to restart the court process. Lastly, a notice of possession hearing announces when the court has arranged a hearing you must attend.
4. A judge reviews your case. They will decide whether your case requires a full hearing. Expect to receive at least 3 weeks’ notice before the review. You do not need to go to court during the review date, but you should anticipate a call over the phone.
5. Attend the possession hearing. If you still cannot reach an agreement with your lender, the court schedules a repossession hearing. Make sure to be present with your attorney. If you don’t show up, the court will likely make a direct possession order, which means you can lose your house. If you cannot come because of valid circumstances (ex. self-isolating due to an illness), make sure to inform the court as early as you can.
6. The court issues a decision. The court issues two types or possession orders: an outright order and a suspended order. An outright order announces the date when you should leave your home. This can be as early as 4 weeks after the hearing. When this happens, you may contact a Shelter adviser for help to possibly extend or reconsider the court order. On the other hand, a suspended order lets you stay in your home according to terms arranged by the court. You must pay a specified amount on top of your regular mortgage payments. In other cases, the lender’s repossession action is adjourned or dismissed.
7. Bailiffs can be asked to evict you. This applies to an outright order when a possession date has been passed. It also applies under a suspended order if you violate terms specified by the court. When you receive an eviction warrant, you have 14 days to leave unless you take legal action.
8. The lender puts your home on sale. If an eviction is successfully passed, the lender can now start selling your property. After the house is sold, the lender and other secured creditors receive their money. If the sale falls short of your outstanding mortgage balance, you may have to pay the remaining debt.
The UK has a competitive and highly developed mortgage market. They offer a wide range of mortgage products for different consumer needs. Like the US mortgage market, lenders in the UK employ thorough background checks and credit reviews before approving a mortgage. They also rely on credit rating systems to help determine a person’s financial reliability. The three main credit reference agencies in the UK are Experian, Equifax, and TransUnion. And though the UK mortgage market has many similarities with the US, it also has plenty of distinctions.
First, fixed-rate mortgages in the UK are structured with fixed rates only in the initial years of the mortgage. After this period, the rate shifts into a standard variable rate (SVR) for the rest of the term. Next, most mortgages in the UK are paid within a 25-year term, while majority of home loans in the US are paid for 30 years with fixed rates for the entire term. When it comes to down payment, historically, UK mortgages required a minimum of 5% deposit. However, due to the COVID-19 crisis, many lenders started requiring a 15% deposit for mortgages.
As for insurance, the UK mortgages are typically sold with payment protection insurance (PPI) or mortgage payment protection insurance (MPPI). These help homeowners cover mortgage payments in case of an emergency. Unlike in the US, mortgage insurance premiums (PMI) are added on top of monthly principal and interest payments. This functions to protect lenders in case a borrower defaults on their loan. However, it cannot be used to make mortgage payments in case of financial hardship.
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