My BRB Mortgage › Mortgages explained
Mortgages in plain terms
A mortgage is two things at once. It is a loan, which is an obligation to repay money over time, and it is a security interest, which is the lender's right to be repaid out of the property if the obligation is not met. Nearly all the terminology attaches to one of those two.
Principal, interest and the level payment
The principal is the amount borrowed. Interest is the charge for having it, calculated on the balance outstanding, so it falls as the balance falls.
A conventional repayment loan uses a level payment: one figure, the same every month, calculated so that the balance reaches zero exactly at the end of the term. The payment is constant but its composition is not. Early on, most of it is interest on a large balance; late on, most of it is capital. The table below shows the shift on an assumed loan.
This is why the early years of a long loan build equity slowly, and why a household that moves after a few years has repaid far less of the principal than the elapsed fraction of the term suggests.
| Point in the term | Interest | Capital repaid | Balance remaining |
|---|---|---|---|
| Month 1 | 1,000 | 199 | 199,801 |
| Month 60 | 932 | 267 | 186,109 |
| Month 120 | 839 | 360 | 167,371 |
| Month 240 | 543 | 656 | 108,007 |
| Month 360 | 6 | 1,193 | 0 |
Deposit and loan-to-value
The deposit is the part of the price not borrowed. Loan-to-value expresses the rest as a percentage of the property's value.
Loan-to-value governs more than eligibility. It usually sets the rate offered, because a lender's exposure to a fall in value is smaller when the borrower's stake is larger, and it usually determines whether mortgage insurance is required. Because lenders band their pricing, small movements across a band boundary can change the rate more than large movements within one.
What else is in the payment
The monthly figure a household actually pays is often larger than principal and interest. Property taxes and building insurance are frequently collected monthly by the lender and held in escrow, then paid to the taxing authority and the insurer when due. Where the loan requires mortgage insurance, that premium is added too, and community or association charges may sit alongside.
Escrowed amounts are estimates and are periodically recalculated. A payment can therefore rise on a fixed-rate loan without the rate changing at all, because taxes or insurance have risen. This surprises a great many first-time owners.
Security, default and what the lender can do
The security interest is what makes the rate on a house loan lower than the rate on unsecured borrowing. If payments stop, the lender has a legal route to recover the debt from the property. The procedure, its timescales and the protections around it differ substantially between jurisdictions.
Between missed payments and any such procedure there is normally a period in which arrangements can be made. The general rule is that the options are wider the earlier the difficulty is raised, and narrower once formal steps have begun.
Portability, assumption and paying off early
Whether a loan can move with the household to a new property, whether a buyer can take over the seller's existing loan, and whether extra payments can be made without charge are all terms of the individual agreement rather than features of mortgages in general. They are worth reading before signing, because they are difficult to change afterwards.