3  Getting the funds together

The first step to buying your own home is determining how much you can afford to pay for a property.

For most people – certainly when buying their first property – the key element is how much you can afford to borrow in the form of a mortgage.

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JONQUIL

If your budget will be a bit tight at first, one option is to look at a fixed rate mortgage. The interest rate is 'fixed' for the first two, three, even five years. The advantage of that is you know exactly what you'll be paying each month for the mortgage. You're protected from any interest rate rise. Some countries have mortgages fixed for long periods like 10 or 25 years, but although there are a few like that here in the UK, they've never really caught on.

Remember, you'd be locked into the same rate year after year. If other interest rates fall, you'd be paying over the odds, so a fixed rate that seems like a good deal at the start can become uncompetitive. Fixed rate mortgages usually have early redemption penalties. These are fees, payable for repaying the mortgage early.

So you would need to weigh up what you'd lose in charges against what you would gain in switching. And you do have to repay the mortgage and then take out another, so it may mean negotiating all over again, even if you stay with the same Bank or Building Society.

The opposite of a fixed rate is a variable rate mortgage, where the interest rate - and so your monthly payments - can go up and down. But again if you're worried about your budget in the early years, you could go for a discounted rate mortgage. In other countries they sometimes call this the "low start" mortgage. Your interest rate and repayments start at a special low rate. The interest rate then goes up to the lender's full rate - called its 'standard variable rate - so you need to make sure you will be able to afford the increased payments. You could look around then to see if you can switch to another low-cost deal.

But discounted rate mortgages usually have early repayment charges that extend beyond the discount period, so - once again - you'd have to weigh those up against the gain from switching. You could opt for a 'capped rate' mortgage. That's a mortgage where the interest rate is variable, but can't exceed a maximum level and so you know your monthly repayments will never go above a certain amount. Like the other special mortgage deals, these are also likely to have early redemption penalties. An alternative product is a collared rate mortgage where there is both a cap on how high the rate can go and a floor below which the mortgage rate cannot fall. These, though, are uncommon in the UK mortgage market.

Offset mortgages are interesting. If you have surplus cash - say in your current account or your savings account - you can move that to the mortgage lender and its deducted from the amount you owe on your mortgage before the monthly mortgage interest is worked out. So if the interest rate received on the savings account is lower than that charged on the mortgage - which typically it is - this can be a good deal. In effect, your savings are earning interest at the mortgage rate. Usually, you can still draw your savings out - for example for a holiday or life's uncertainties - then of course, the interest charged on the mortgage goes up.

The interest rate on an offset mortgage is usually a bit higher than other lenders would charge. Whether it's a good deal really depends on the amount of savings you can offset. You might want to consider a flexible mortgage. A variable rate mortgage where you can choose to vary your monthly payments and sometimes borrow back money you've already paid off. Obviously being able to reduce your payments could be useful if you're going through a tough time financially. But flexibility is good the other way too.

Most mortgages these days let you pay off extra if you want to. That means you pay off your mortgage faster and pay less interest in total. However some people worry that, with the freedom to reduce payments in bad times, they won't push their payments back up enough in the good times. Like when you're on holiday, you don’t want to go back to work. With a fixed or variable rate mortgage, you pay whatever the lender tells you to pay each month - and that inflexibility is sometimes helpful, if you want to be disciplined about repaying.

Shared ownership schemes are becoming more available - they're often aimed at first-time buyers who can't pay a big deposit, or easily afford the payments on a full mortgage. The idea is that you partly buy and partly rent your house.

For example, you might buy 75%, and take out a mortgage on that. Then you pay rent on the other 25%. You still have to pay a deposit on the share that you're buying - but it can work out cheaper per month than buying the house entirely. And when you can afford more repayments, you can increase the share you're buying. For shared ownership you have to buy a house or flat from a housing association, or sometimes a property developer. That often means it'll be a new-build property, especially if you choose one of the special schemes backed by the government. The housing association sometimes has first-call on the property if you want to sell it. And not all banks and building societies will lend for shared ownership - but most do.

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There are many different types of mortgage product. In the video financial services expert Jonquil Lowe guides you around the mortgage market.

Mortgages are simply loans used to buy property or land. Typically the term of a mortgage is 25 years – although they can be for longer or much shorter terms.

For most mortgage lenders the maximum they will be prepared to advance you is 95% of their valuation of the property you’re buying. This means that you will have to cover at least 5% of the property cost – through money you’ve saved or perhaps via a donation from your family.

Setting up a Lifetime ISA will help you save up for a deposit for your first home. These ISAs, launched in 2017, allow tax-free savings of up to £4000 per annum with the government topping up balances by £1 for every £4 saved. Lifetime ISAs, which can be built up until the age of 50 years, are intended to help people save for a first property purchase.

You should certainly try to get together as large a deposit as possible. One of the key factors in the amount of interest you pay on your mortgage is the amount of deposit you put down in relation to the value of the property. To put it another way, the lower the size of the mortgage that you need in relation to the value of the property, the lower the interest rate on the mortgage you’re likely to have to pay. This is because the lower the ‘loan-to-value’ the lower the risk of lending to you is from the perspective of the lender.

There is one over-arching control, though, on the size of the mortgage. This is the ‘affordability test’. When you apply for a mortgage the lender will conduct a detailed exercise to establish how much you can realistically afford to borrow. They’ll work through the following stages.

• Analysing your income and spending for at least the previous 3 months before you apply, to ascertain your budgetary position.
• Ascertaining whether you’re in permanent or temporary employment. Not having permanent job is a negative factor in affordability tests as lenders will be concerned about the potential drop in household income once the temporary job ends.
• Detailing all your financial commitments. This will include existing debt repayments that you have to make and might also cover education costs for children (nursery and school fees), transport costs (car lease payments) and, perhaps, the cost of gym membership.
• Stress testing your budget to see if you could still afford to repay your mortgage if the mortgage rate rises sharply (typically by 3%).

One thing to remember is that if you cover part of the property purchase cost through another loan (even a loan from your parents) the costs of the loan will be included in the affordability calculations and will therefore reduce the size of the mortgage offered to you. This is why if your family is supporting you when you buy your home they will need to complete a ‘gift agreement’ that states that the money given to you is a gift (it does not have to be repaid) as opposed to a loan (it does have to be repaid).

Affordability tests vary from one lender to another and some are more generous than others. However current evidence indicates that if you have an income of £30,000 per year then – at the interest rate levels seen in recent years – the mortgage you’re likely to be offered will be between £85,000 and £125,000. You can scale this range up and down based on how your income compares with £30,000 per year. Clearly if your outcome is towards the bottom end of the range you should really try an alternative mortgage lender or get a mortgage broker to seek out the best deal for you. Brokers will normally charge a fee and might also receive commission from the mortgage provider.