The Importance of Understanding The Mortgage Game

If you want to buy a property, usually you have to buy it with a combination of your money (being your deposit) and the bank’s money (being the mortgage).  In my experience the combination of your money to the banks is 10:90.  That is to say the bank contributes a substantial amount, being 90% of the purchase price and you contribute 10%.

So guess how important the purchase is to the bank compared to you? About 9 times more important!  That is why understanding how they operate is very important.  If they don’t want to lend to you then you can forget about owning any property unless you have enough to buy the property for cash.  Buying Power is highly dependent on being able to obtain a mortgage.  Chapter 5, ‘Increasing your Buying Power by Increasing Your Status Ranking’, deals with pruning yourself for getting a mortgage.

Once you understand the mortgage game we can use this knowledge to exploit them.  I use the term ‘game’ because it is a game – you have to jump through their hoops.  We cannot eliminate these hoops but we can certainly lower these hoops so they’re easier to jump through.  Chapter 6, ‘Increasing your Buying Power without increasing your Status Ranking’, deals with this very topic.

What Mortgage Companies Look for

In a nut shell, what mortgage companies look for are - are you a good bet?  How do they establish this?  Well, I think you might remember this from previous chapters:

  1. Whether you save money and how much
  2. How much you earn, how you spend money and the amounts spent
  3. Your credit history

So mortgage companies need to establish the above.  So how do they do this?  Find out how they do this and, more importantly, how to exploit this below.

  1. Whether you save money and how much

This, apparently, is easy for them to establish.  Most mortgage lenders will want to know that you have the ability to save money for a rainy day – a typical rainy day being that you lose your job and can’t afford the mortgage.  A person that saves will have money put aside for this rainy day.  So how do they know if you save money?  Well if you have a cash deposit to put down to buy a property then the mortgage lenders think you can save money – regardless of where that cash deposit came from!

I say most lenders, some do not.  These are called 100% mortgages.  That is to say they lend 100% of the purchase price.  Some lenders even lend in excess of 100%.  There are a few specialist lenders out there that offer up to 115% of the purchase price.  In effect – they pay you to buy a property!

Generally though you need at least 5% deposit.  The more deposit you have the better range of interest rates you get.  When you have a deposit of 25% then you have choice of virtually the whole market.  So the more you save now to put down the less you will pay in interest.  Let me show you this example of how much you could save:

Emily wants to buy a house for £100,000.  She has £10,000 to put down.  She finds out that she can get a mortgage for 5% interest rate for 25 years if she puts a 10% deposit down.  She then passes a car garage selling a beautiful BMW for £5,000, and guess what, she just couldn’t resist it and pays for it out of her deposit.

She then finds out that if she puts only a 5% deposit she has to pay 5.5% interest rate.  So lets look at the costs:

If she didn’t buy the BMW:

£90,000 x 5% x 25 years = £112,500 total cost of interest

If she did buy the BMW

£95,000 x 5.5% x 25 years = £130,625 total cost of interest

[Interest only mortgages]

So the difference in cost is £18,125.  So in effect the BMW, worth £5,000, cost £18,125!  That’s bad value.  If she spent the whole £10,000 on a better BMW the difference would have been even worse.  She would have lost around £30,000.

So hopefully you can see the power of having a deposit.  If you have any cash put away – preserve it, it’s precious.

  1. How much you earn, how you spend money and the amounts spent

What mortgage lenders need to know are:

  1. Can you afford to pay back what they’ve lent you including the interest?
  2. Can you do this for the duration of the loan?

It’s called serviceability.  They will judge this on:

  1. How much you earn
  2. How and what you spend your money on
  3. How long you’ve been in your current employment or self-employment.

These factors seem reasonable.  Would you lend £1,000 to your friend that has been unemployed for 3 years, spent the majority of his dole money on cannabis and just started a job in McDonalds earning £5 per hour?  I know I wouldn’t!  So its not unreasonable to expect a mortgage lender to know a little bit about how we earn and spend our money.

So the first question they’re going to ask is how much do you earn?  Lenders do not like to lend more than what you can afford.  They estimate that up to 30% of your salary can be used to pay a mortgage.  It is likely that the other 70% will be taken up on other living expenses such as travel, household bills, food and clothing.  Based on this they will lend around 3 to 4 times your salary.  This multiple, 3 or 4 times your salary, was set a number of years ago when interest rates were around 8%.  Due to low interest rates you will find out that you will be able to afford up to 5 times your salary and there are certain lenders out there that know this and offer mortgages based on this.

So once they know how much you earn they need to know how you spend it.  Lenders do not automatically lend 3 to 4 times your salary.  They need to know that there is that actual surplus of around 30%.  Take, for example, Ken, who earns £2,000 per month.  If he’s got a car on HP, insurance costs, various loans, credit card debts and travelling expenses totalling £1,900 then they will not lend to him.  This is because in his current state he can’t even afford to pay rent – let alone a mortgage!   Lenders usually ask for an affordability statement.  This is a statement where you detail what money comes in and what money goes out.

After finding out how much you earn and how you spend it they need to know if the money is still going to keep flowing in!  They base this on length of employment.  The usual time periods are:

    1. 1 year for employment
    2. 3 years for self-employment

How you prove this to the lender is wage slips for the last 3 months for the employed or 3 years accounts certified by a qualified accountant for the self-employed.

What you’ll find out in Chapter 6, Increasing Your Buying Power Without Increasing Your Status Ranking, is that there are lenders that are willing to be a little bit flexible in making these judgements.

  1. Your credit history

You may be a good bet now – but were you in the past?  They will need to establish your creditworthiness in the past and present so they can predict your creditworthiness in the future.

There are two main credit reference agencies that all lenders consult before they make any lending decision, Experian and Equifax.  They record a number of details about you based on your current and previous addresses in the last three years, namely:

  1. Electoral Roll – whether you are on the electoral role. Some lenders require you to be on the electoral role before they can lend.
  2. County Court Judgments (CCJs) – These arise when you have been taken to court by a debtor to enforce payment of a debt and the debtor won the case. The court hold this information for six years from the date of the judgment.  They also record if you subsequently paid the judgement.
  3. Individual Voluntary Arrangements (IVAs) – This is where you have become bankrupt and unable to pay your debts. Once you have been made bankrupt and the debts have been settled then you become a discharged bankrupt.  Only once you have been discharged can you have any hope of obtaining credit again.  You are automatically discharged after six years.
  4. Credit Accounts – these are all your loan accounts that have been active in the last six years and whether you have ever defaulted on them. Typical accounts are your mortgage account, credit and store card accounts and personal loans.
  5. Repossessions – details of any house repossessions that have ever occurred.
  6. Previous searches – these are previous credit searches by other lenders that you have made a credit application with.
  7. Gone Away Information Network (GAIN) – this is where you have moved home and not forwarded on the new address and not satisfied the debt.
  8. Credit Industry Fraud Avoidance System (CIFAS) – this is where the lender suspects fraud and just flags it up. You cannot be refused credit based on a suspicion.

Your credit file dictates the mortgage you can get.  The key factors are CCJs or defaults.  If you have any CCJs or defaults (points 2 & 4 above) you will be restricted to adverse credit lenders who charge higher arrangement fees and interest rates.  If you have an IVA, repossession or GAIN on your file it is unlikely you will get a buy-to-let mortgage but you will be able to get a residential mortgage depending on when you had debt problems.  It is worth noting that the buy-to-let mortgage market is further developing and a suitable product may come on to the market soon.

There is one key thing you should remember when filling out your form – do not lie!  If lenders find out they will demand repayment in full and they could inform the police of fraud – the charge being obtaining finance by deception.  The credit reference agencies are becoming more and more sophisticated.  They log every bit of information you put on every credit application and if you submit an application that was slightly different from a previous application  they will flag it up.

There is a list of adverse lenders in the reference chapter.

The Main Reasons Why People Are Declined

  1. When you apply for a mortgage or any type of credit, a lender will look into your credit history by contacting Experian or Equifax, the credit reference agencies. If they’ve found out that you have failed to repay your debts in the past, it will affect your chances of getting a mortgage, loan or credit card.  Late payments, County Court Judgments (CCJs) and Repossession Orders can all lead to refusal.
  2. Lenders will also take into consideration the debts you have already and compare this to your income. If they believe you have insufficient funds to repay the loan, again they will turn down your application.
  3. If you have been "shopping around" for credit, there will be searches registered on your credit file. In some cases this will be sufficient reason for lenders to refuse you any further credit even though you have no intention of taking the credit applied for.

The Different Types of Mortgages

There are three core elements to a residential mortgage.  They are:

    1. Whether its an interest only or repayment mortgage
    2. The interest rate
    3. Whether there are any incentives

Interest Only or Repayment

Interest Only Mortgage

This mortgage is self explanatory – you pay the interest only on the balance.  So for example, if you buy a house for £100,000 with a 5% deposit, then you have to borrow £95,000.  You will pay the interest charged on this balance only for the duration of the mortgage – usually 25 years.  At the end of the 25 years you have to pay back the £95,000.  Borrowers usually pay this balance by either selling the property or by cashing in a savings plan maturing at the same time as when the mortgage balance becomes due.

I would recommend anyone that is trying to get on the property ladder to strongly consider interest only mortgages. Choosing this mortgage ensures the lowest monthly payment.  My mortgage is an interest only mortgage so I can afford the payments.  Having a repayment mortgage can increase payments by up to 25%.  I have no savings plan as I intend to move house, rent the existing house out and then sell it at a later date.

Do not worry if people tell you that you will never own your home.  Its unlikely that the house you buy first is the house you will be living in in 25 years.  The likely scenario is that you will sell the first house you buy within 5 years to buy the next.  The benefit of the positive cashflow over these 5 years far outweigh the extra interest you pay for those 5 years.  Only when you have found the property you wish to live in for the rest of your life do you ever consider a repayment mortgage.

Repayment Mortgage

This is where you pay interest and a fraction of the capital back in one monthly payment.  So for example if an interest only mortgage is £300 per month and the repayment mortgage is £400 per month for the same amount borrowed then the capital repayment is £100 per month.

The capital repayment is a discretionary cost.  You can either pay it or not!  Why pay it if you can use this £100 to better use.  Good uses for this extra £100 would be for improving your property, paying off credit cards or saving it to make other investments such as stocks and shares.  Only ever consider a repayment mortgage when you have found your ultimate dream home.

The Interest Rate

There are only two categories of type of interest rate – fixed or variable.  There are various sub categories of this in the table below:

FIXEDFixedThis is for the low risk-taker.  It ensures that the monthly mortgage payment is fixed for a period of time, usually between 1-10 years.
CappedThis is also for a low risk-taker.  It ensures that the mortgage payment never exceeds a certain amount but if interest rates fall then your mortgage payment can fall.  No downside risk and only upside potential!
VARIABLETrackerThis is where the interest rate being charged follows the exact rate being set by the Bank of England + an interest loading, typically 1-2%.  You are fully exposed to the Bank of England interest rate fluctuations.
DiscountThis is where the initial interest rate is discounted by 1-4% for a specified period of time.  This could be a discount on a tracker or a standard variable rate.  You are exposed but because there is a discount in place you don’t feel the fluctuations quite as badly.
SteppedThis is where the discount is reduced over a number of years.  So you would be entitled to a 3% discount in year 1, 2% discount in year 2 and 1% discount in year 3 for example.
VariableThis is just the standard variable rate set by the lender.  Your mortgage payments are fully exposed to interest rate fluctuations.

You have to be careful of the tie-in/lock-in periods that may exist with all these products.  These are the minimum periods that you have to remain with the lender without incurring financial penalties if you wish to redeem the loan because you want to sell or remortgage the property.  These are called redemption penalties.

Whether There Are Any Incentives

There are 3 key incentives to mortgages:

  1. Cashback
  2. Valuation and/or Solicitors fees refunded
  3. Flexible
CashbackThe first mortgage I got was a cashback mortgage.  It means you get a cash back when you complete the purchase.  It ranges between 1% to 10% of the amount borrowed.  There is invariably an extended tie in with these with the penalty being the full repayment of the cash back given when the mortgage was taken out.
Valuation and/or Solicitors fees refunded


Because lenders are desperate for your business they will even pay for all the fees associated with buying a house.  This includes the initial valuation fee, solicitor’s costs, arrangement fees and if your lucky a small cash back to help with the moving costs.
FlexibleThis is a great new introduction to the mortgage market.  It enables you to offset all your savings and income against your mortgage.  The result is that you save on interest costs due to your savings reducing the overall balance of your mortgage.

Choosing The Right Mortgage

Even though the mortgage you will be able to get will depend on your status ranking you will still have a choice.  The higher up the status ranking you are the wider the choice.  Guidance is needed on making this choice.  The choices will be:

    1. interest only or repayment mortgage
    2. type of interest rate
    3. Whether you need any incentives

The choice of mortgage is common sense as long as you have thought about the following things:

  • your attitudes to risk
  • the type of property
  • how much of your income you want to spend on your mortgage
  • when you think you are going to move
  • degree of aftercare
  • the purchase price
  • money needed after completion

By thinking about these five factors you can build your profile.  Lets look at these factors in more detail.

your attitudes to risk


The risk is that the interest rate rises so the mortgage payment becomes unaffordable.  To mitigate this risk you simply go for a fixed rate.  If you are willing to accept a degree of risk you go for a capped rate.  If you are quite open to risk then you go for a good standard variable rate.  See above for the definitions.
the type of property


Lenders have certain exclusions based on the type of property it is.  The key exclusions are:

1.     Studio Flats – These are flats that have one main room that is used as a lounge and bedroom, plus a kitchen and a bathroom.  They are excluded as they can be difficult to sell if there was a property price slump.

2.     Ex-Local Authority Houses & Flats – These are properties that were once owned by the local council and subsequently sold on to private people.  They are excluded as they are associated with the lower end of the property market.

3.     Flats above commercial properties – These are excluded as the commercial property below could be let out to an Indian or Chinese take-away at some later date.  Because of the smell of the food it would lead to a decline in the market value of the property.

4.     Flats with more than four storeys – These will be considered as a high rise block and at the lower end of the property market.

5.     Multiple Title properties – These are properties where a freehold exists with a number of long leases and you are trying to buy the freehold.  An example of this is a block of flats.

6.     Non-standard Construction – If a house is not built with bricks or does not have a pitched tile roof it is deemed non-standard.  For example some houses may be constructed from poured concrete.  Despite being perfectly fine houses, lenders may consider these properties inferior to the standard construction properties.

how much of your income you want to spend on your mortgage


If you want to spend only, say £300, on your mortgage payment then you go for a mortgage that can do this for you.  You can opt for an attractive discount rate that reverts to the standard rate when you know that you would have had a pay rise in that time period.  Or you can go interest only that keeps the payment within your budget.
when you think you are going to move


If you intend to move after 3 years then avoid a mortgage that has a tie in period greater than 3 years.  This avoids an expensive redemption penalty when you sell the property.
degree of aftercare


If you want face to face communication with your lender then only go for high street lenders that have branches in your area.
the purchase price


Almost all lenders have a minimum purchase price.  The minimum purchase price starts at £6,500 and rises up to £75,000 for certain lenders.  If your purchase price is below their minimum purchase price then the lender will not consider you under any circumstances.
Money needed after completionIf you want to redecorate your new place then you will need cash.  You can create cash by getting a cashback mortgage or save cash by taking advantage of the lender paying for all the fees for valuation and solicitor’s costs.

So a typical profile might be:

your attitudes to riskLowGo for a capped or even fixed rate mortgage.
The type of propertyEx-Local Authority HouseMake sure you go for a lender that accepts ex-local authority houses.
how much of your income you want to spend on your mortgage£400Ensure that the mortgage payment does not exceed £400.  This may involve going for a discounted rate on interest only if the purchase price is high.
when you think you are going to move3 yearsIgnore all mortgages that have greater than a 3 year tie in.
degree of aftercareLowNon-high street lenders are suitable thus able to get better rates.
the purchase price


Min £45,000 Max £60,000Ignore all lenders with minimum valuation below £45,000.
Money needed after completion£1000Could go for a fee free mortgage or for a cashback mortgage of at least £1,000.

So with your typical profile and your status ranking you can pretty much narrow down the right mortgage for you.