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How does interest on mortgages work?

Learn more about how mortgages work

When choosing a mortgage, the interest rate you’ll be charged is one of the most important factors. Here we explain how interest on mortgages works

By Kevin Pratt

Published: 04 July 2019

How does interest on mortgages work

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On the whole, the lowest interest rates are available to borrowers who have large deposits, or in the case of those remortgaging, significant equity in their property. Typically, you’ll need at a deposit of at least 40% to be eligible for one of the best rates. If you have only 10%, there are mortgages available but you’ll probably pay a higher rate.

This is advertised as loan-to-value (LTV).  So if you see a mortgage with a 60% LTV it means you can borrow up to 60% of the property’s value.  In other words, the minimum deposit you’ll need to put down is 40%. A mortgage with a maximum LTV of 90% is available to those with a deposit of 10% or more.

Don’t only look at the interest rate, though, you need to take the fees into account too.  Our guide on fees will tell you more.

How does a mortgage work?

Your mortgage is made up of the capital – the amount you’ve borrowed – and the interest charged on the loan.  With most mortgages you pay off the capital and interest monthly over 25 or 30 years, which is why they’re called repayment mortgages.

In the early years, most of your payments go to paying off the interest with a smaller part reducing the capital.  As you get nearer to the end of the term, it switches so that you’re paying more off the capital each month.

You can opt for an interest-only mortgage where, as the name suggests, you just pay the interest every month. However, you’ll have to pay off the capital eventually so it’s important to have a repayment plan in place. The number of lenders offering interest-only mortgages has reduced over the last few years because there are concerns that many of those who have them have no repayment plan in place and could be left unable to pay back the capital at the end of the term. 

 

Your home may be repossessed if you do not keep up repayments on your mortgage

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