How to Calculate Mortgage Payment Levels

The basic questions and the place to start is to calculate the mortgage payment levels you are comfortable with by working out::

* How much mortgage you can afford
* The size of mortgage you could be given
* The type of mortgage you should get
* The kind of loan repayment schedule that suits you

How much mortgage can you afford?

Look at your earnings, savings and expenses, prepare a budget factoring in all your day to day expenses, include any loans, credit cards and savings, a figure to cover any unexpected costs may also be worthwhile. How will your budget be affected by a mortgage? Some expenses like rent will disappear but a mortgage will bring other expenses such as life assurance cover. This information will also be asked for from your mortgage lender, especially if you are asking for more then they would usually lend.

What size of mortgage could you be given?

The size of the mortgage you could get is based on your income, the property and your ability to afford the repayments. In these changing financial times every lender is different but a useful rule of thumb would be to use a conservative figure of 2.5x your combined income if buying with a partner or 3x your income if buying by yourself. If you have a large amount of disposal income after expenses and you can prove this to your lender you are likely to be allowed to borrow much more. Income multiples of 4x income are not unusual.

Your lender also needs to agree that the value of the property you own or plan to buy is worth at least the loan amount. The property is their security, if you were to default on the loan they could take steps to reposses and sell the house and get their money back. A mortgage lender will instruct a surveyor to value the property on their behalf before giving you a mortgage offer.

What type of mortgage should you get?

The two most common types of mortgages are repayment mortgages and interest only mortgages. You can also have a combination of the two, combine them with insurance policies, connect them with stock market investments and your current/savings accounts.

Repayment Mortgages

Repayment mortgages are the most popular mortgages in the UK and work on the basis that all of the interest you will pay on the mortgage during the whole term i.e. 25 years is calculated by your lender (known as the interest amount) and added to the loan amount (known as the capital amount). Your repayments then pay off a bit of both the capital and the interest amount every month. The calculation is weighted so you pay off the interest first. A repayment mortgage is a way you can guarantee that your mortgage reduces to zero over the full mortgage term.

Interest Only Mortgages

An interest-only mortgage is where you only pay the interest amount in your monthly repayment, the capital amount remains outstanding, you will still owe this amount to the lender. In the past it was common for people to take out an insurance policy to cover the capital amount, this type of mortage was known as an endownment mortgage which has since been discredited due to the policy amount often being less then what was left to pay on the mortgage.

The capital amount can be repaid through savings, linking it to seperate investments or by simply selling the property. Interest only mortgages offer a lower monthly payment and are useful for people in certain situations such as those looking to resell the property in a short space of time or those where their income is guaranteed to rise. As this mortgage repayment method does not guarantee that you will own the property at the end of the term they should be used with caution by most homebuyers..

What kind of loan repayment schedule suits you best?

When you have settled on the type of mortgage that suits you there are other options it may be worth considering and confirming with your lender.

Mortgage Closing Costs

What are your mortgage closing costs? Mortgage closing costs also know as Early Redemption Penalties are payable if you were to pay off your mortgage early. A desirable situation for many people but rarely for your lender who will not be able to earn as much interest as the length of the term will be shorter. To make up for their reduction of income (interest) some may ask you to pay them this or another large payment (often a %) before closing your mortgage. It's well worth clarifying this in advance as all lenders are different.

Life Assurance

It is likely that your lender will ask you to insure your life for an amount close to the loan amount. This is to cover them in the event of your death. The insurance policy will essentially repay the mortgage company if you die meaning the property can be passed on to your next of kin with no loans outstanding. Something to be aware of is that the insurance policy offered by your lender may not be the most competitive, you are not obliged to use the same lender for your assurance as your mortgage. Make them earn your business compare quotes and negotiate with your lender if you want to keep everything in the same place.

Length of term

Although the majority of mortgages are taken out over a 25 year term, your mortgage could be repaid over 5, 10, 20, 30 or any number of years depending on your position and preference. The thing to bear in mind is that the longer the term the higher the overall amount you will have to repay is with interest. Shorter terms will mean higher monthly repaymants but a lower total cost overall.
Understanding Variable, Discount and Fixed Rates

A fixed rate is where you and your lender agree an exact interest rate in advance for a fixed period of time, for example for the first 2 or 3 years. For those who want the guarantee of knowing what their monthly repayments will be, this is a good option, fixed rate deals are often very competitive and used by lenders to attract new customers. The thing to bear in mind with fixed rates is that when general interest rates set by the Bank of England go up, you are in a good position as you will have fixed your repayment rate at a lower level. When rates go down the opposite is true and you may find yourself paying more than you would have otherwise.

The variable rate also known as SVR (Standard Variable Rate) is the interest rate a lender uses as their standard rate and is subject to change and directly related to the base rates decided by the Bank of England. A good rule of thumb is that most lenders SVR will be 2% or so higher then the Bank of England base rate. When the Base rate goes up so do all of the lenders SVRs, when base rates go down, so do the lenders SVRs.

A discount rate is where for a period of time say for 2 or 3 years the rate you will repay on your loan will be x% lower then the lenders Standard Variable Rate.

Shop around to keep your Mortgage Payment Levels Low

Lenders earn a living through earning interest on money that they lend to people. Ignoring the nonsense that the financial services industry has recently indulged in, as a rule a lender should only lend out money that they have in reserve. i.e. the flip side of the lending coin is other people savings.

The lender will esentially lend you other people's money and take a cut. Depending on if your lender needs to find more money to lend (attract more savers) or has more saver's money to lend (needs to attract more borrowers) the lenders interest rate will reflect this. For example Interest rates will be high when they need more savers and low when they need more borrowers, regularly monitoring what your lender is doing and changing to different lenders when their interests are not the same as yours is also worth thinking about before agreeing on a lender. How easy is it to move away from the lender? What are the penalties if you do so?
I hope this guide has been useful, but please be aware that we are not qualified mortgage advisers and that specialist advice should be taken before acting on anything written here.