Mortgages in plain terms
Underneath the vocabulary, what is a mortgage actually doing?
A mortgage is a loan secured on a building. Underneath every product name there are four variables and one piece of arithmetic. Everything else is packaging.
The four variables
- Amount borrowed. The price less your deposit.
- Rate. The annual cost of the borrowing, and critically whether it is fixed for a period or moves.
- Term. How long the repayment is spread over.
- Repayment structure. Whether each payment reduces the debt or only services the interest.
The arithmetic, and what it does to intuition
In an ordinary repaying loan, each payment is split between interest on the outstanding balance and repayment of that balance. Because the balance is largest at the start, the early payments are mostly interest and the later ones mostly principal. Three consequences follow, and all three are counter-intuitive:
- Extending the term lowers the monthly payment considerably and raises the total interest paid substantially. The monthly figure improves; the loan gets more expensive.
- Overpaying early is far more effective than overpaying late, because it removes interest for every remaining year.
- In the first years, the equity you own grows mostly from price movement, not from repayment. This is why an early forced sale in a flat market can leave very little.
Rather than quote figures, do it yourself with any repayment calculator: hold the amount constant and vary the term, then vary the rate by one point. The shape of the answer is the thing worth learning; the specific numbers are yours and today's.
Fixed and variable, honestly
A fixed rate is not a bet on rates; it is the purchase of certainty for a period, and the lender charges for that certainty. A variable rate is cheaper on average and transfers the risk to you. The right question is not which will be cheaper, which nobody knows, but how much a rise would hurt: if a two-point rise in payments would be uncomfortable rather than survivable, the certainty is worth paying for regardless of forecasts.
The vocabulary that hides the four variables
| Term | In plain words |
|---|---|
| Loan-to-value | The share of the price you are borrowing. Lower means less risk to the lender and usually a better rate. |
| Amortisation | The schedule by which the balance is repaid across the term. |
| Escrow | The lender collecting taxes and insurance with the payment and paying them for you. |
| Points | Paying money at the start to buy a lower rate. Worth it only if you keep the loan long enough. |
| Mortgage insurance | Insurance protecting the lender, paid by you, usually required when the deposit is small. |
| Underwriting | The lender checking both you and the building before committing. |
| Prepayment penalty | A charge for repaying early, which cancels the value of overpaying. |
Comparing offers
Compare the total cost over the period you realistically expect to hold the loan, not the headline rate. Fees, points, insurance requirements and any early-repayment charge all belong in that total. Two loans with the same rate can differ substantially once the arrangement costs are included, and the difference usually favours whichever one was harder to read.
The affordability question the lender does not ask
A lender asks whether you can pay it. That is a narrower question than whether you should. Its assessment excludes the maintenance reserve for a roof you will eventually replace, the commuting cost from that specific address, and the possibility of a period of lower income. Those belong on your own worksheet, not the lender's.