When you’re applying for a mortgage, one of the first things you’ll need to consider is the mortgage term. This refers to the number of years it will take to repay your loan, as well as the interest.
When you take out a mortgage, you’ll have to decide on a mortgage term that meets your needs, both now and in the future.
The longer the term, the lower your monthly repayments will be. But the longer you spend paying off your loan, the more interest you’ll end up paying, and the older you’ll be when it’s fully repaid. It may seem odd thinking about this now, but the term might extend into your planned retirement.
So, the mortgage term that will be right for you will depend on several factors, including your age and your financial circumstances, or the joint financial position of you and anyone else you might be borrowing with.
How long is a ‘normal’ mortgage term?
Actually, there’s no such thing. Traditionally home-buyers have tended to go for a 25-year mortgage. This is because mortgages used to be linked to long-term investments, called endowments, that were used to repay the capital. However, most lenders will offer longer terms to help spread the cost of a mortgage over 30 to 40 years, or more, depending on your age.
When you apply for a mortgage, you can choose the term you think you can most comfortably afford. Lenders use the mortgage term as a key part of their affordability assessment, which will determine how much they’re prepared to lend you. It’s worth checking out some repayment calculators to compare how longer and shorter periods of time could affect your monthly repayments. By extending the loan period, you might be able to borrow more, but this will impact how much interest you’ll also pay.
What are the different ways you can repay your mortgage?
With a capital repayment mortgage, you pay off the interest and some of the capital each month. With interest-only mortgages, you only pay off the interest on the amount you borrow.
Repayment mortgages
If you want to pay off the amount you’re borrowing, together with the interest, the most common way is by choosing a repayment mortgage. The payments you make every month will gradually pay off the original amount you borrowed, as well as the interest on the loan. The amount of capital you repay each month will be determined by the mortgage term, which means the longer you take the mortgage term, the less capital you pay and the more interest – which means you have an overall lower monthly payment. The opposite is true with a shorter term.
Interest-only mortgages
If you have an interest-only mortgage, the mortgage term doesn’t impact how much you pay each month, as you’re not repaying your mortgage as you go along. Therefore, the amount you pay is simply the interest on the mortgage balance. So the term is the length of time it takes until you stop paying interest. You’ll then need to repay the full amount of the loan.
So, whilst you can have a longer term, all this does is increase the total amount of interest you’ll repay, but it won’t change the amount you can borrow. Of course, having a longer term will give you more time to ensure that you’re able to repay the mortgage when it becomes due.
To be considered for an interest-only mortgage, the lender will need you to prove you can repay the loan at the end of the term with things like savings, investments, or pensions. Most lenders will have a maximum loan-to-value (LTV), which is usually somewhere between 60%-75%. And they will set a minimum property value to help ensure that you’re more likely to have a lump sum of equity should you choose to sell your property when your term ends.
How does the length of a mortgage impact the cost?
The longer the mortgage term you choose, the more interest you’ll pay over the duration of your loan.
For example, the table below illustrates how much interest you’ll pay* over the full term of a mortgage loan if you’re buying a home for $225,000, with a 10% deposit of $22,500, and a fixed mortgage interest rate of 5%.
How can you work out the mortgage term that will suit you?
Everyone’s circumstances are different. You might have a bigger than average deposit to put down, or you might have some debt that you want to repay while also repaying your mortgage. Mortgage lenders will consider your spending commitments, as well as your income, before deciding how much they’ll lend to you.
You can choose a mortgage term which aligns to your budget and what you feel comfortable paying each month. It can be really helpful to discuss your options with a mortgage broker or your lender’s in-house adviser.
The mortgage term is a major factor in determining your monthly payments, but the product choices you have available to you are also important. Lenders offer a range of rates and fee choices.
For example, you may be offered a mortgage with a product fee, but at a lower interest rate. The bigger your loan size, the more beneficial it can be to pay a fee, because this gives you access to a lower interest rate, which can mean that you end up repaying more of your balance. This can be quite complex to figure out, so you should ask your broker or lender’s adviser to show you the financial impacts of the difference between a no fee product, paying a fee or adding it to the loan – and how this is impacted by your mortgage term.
If your mortgage term goes beyond the age you think you’ll retire, your lender is likely to ask you questions about your income in retirement. They’ll want to know that you can continue to make your mortgage payments when you’re no longer working. But if you’re a long way from retirement, the lender will just generally want to see that you’re planning and saving for retirement by checking things like your contributions to workplace pensions.
Therefore, choosing a term that will take your mortgage into your planned retirement may impact both the questions that lenders ask you, and the amount that you can borrow.
A mortgage broker – or your lender’s in house adviser – can help you to work out how you balance all these competing considerations and choose a mortgage term that will meet your needs.
Can you change the term of your mortgage?
Yes, but there are some eligibility restrictions on tinkering with your mortgage term. If extending your term takes you beyond retirement, your lender will need to do further assessments. This may also apply when you reduce your mortgage term and increase your monthly payment – as the lender may need to check that your payments are still affordable.
You can speak to your lender about extending or reducing your existing mortgage term at any time. Most lenders don’t charge fees for changing the term of your mortgage. Some lenders will let you do this online too, either via a form or by showing you the cost implications of your choices.
If your financial situation changes – for example, if you’d like to reduce your monthly repayments to free up a bit more money – you might be able to extend your mortgage term accordingly. If you’re struggling to meet your monthly repayments, you should always speak to your lender who will have a range of options available to you.
You can also apply for a new term if you’re looking to remortgage or when you do a product transfer, or rate switch, with your existing lender.
Could overpayments reduce the term of my mortgage?
Yes, overpaying your mortgage can be used to shorten your term. So, you can choose to make overpayments to reduce the amount of interest you pay, but early repayment charges may apply. Many lenders allow overpayments of up to 10% of the outstanding balance of your loan, without you having to pay a fee.
How does your age impact the length of mortgage you choose?
If you’re in your twenties or thirties, you’ll be eligible for a longer mortgage term, because lenders assume you’ll still be working until it’s paid off. Typically, lenders cap mortgage terms at a maximum of 40 years.
Lenders will need to understand when you intend to retire, because they want to be sure you’ll be able to continue your repayments throughout the full term of the mortgage.
Please note: Hadsul is not authorised to give financial advice; the information and opinions provided in these articles are not intended to be financial advice and should not be relied upon when making financial decisions. Please seek advice from a specialist mortgage provider.
