Mortgages in plain terms
| Principal | The amount borrowed. Everything else in the loan is a rule about how this number is repaid. |
|---|---|
| Rate | The price of the money, expressed annually. It may be fixed for a period or track something. |
| Term | How long the repayment is spread over. A longer term lowers the payment and raises the total interest. |
| Amortisation | The schedule by which each payment splits between interest and principal. Early payments are mostly interest. |
| Loan to value | The loan as a share of the property's value. Lower ratios generally access lower rates. |
| Security | The lender holds a charge over the property. This is what makes the rate lower than unsecured borrowing. |
| Affordability test | The lender's assessment of whether payments remain sustainable if circumstances or rates change. |
A mortgage is an ordinary loan with one distinguishing feature: it is secured against the property. Because the lender can recover the debt from the property if payments stop, the rate is far lower than on unsecured borrowing. Every other feature follows from that basic bargain.
The four numbers
Principal, rate, term and repayment method between them determine everything. Principal is what is borrowed. Rate is the annual price of it. Term is how long repayment is spread across. Repayment method decides whether each instalment reduces the principal or only pays the interest.
On a repaying loan the instalment is constant but its composition changes. At the start, most of it is interest, because interest is charged on a large outstanding balance. As the balance falls, more of each payment goes to principal, and the balance falls faster. This is why overpayments made early reduce total interest far more than the same amount paid late, and why the first years of a long loan feel as though they achieve little.
Fixed and variable
A fixed rate holds for a stated period, after which the loan reverts to something else. A variable rate moves, either at the lender's discretion or by tracking a reference rate. Fixing buys certainty for a period and usually costs a little more for it; it may also carry a charge for repaying early. Neither choice is universally correct, and the right comparison is not which is cheaper today but which set of risks a household is better placed to carry.
Loan to value
The loan expressed as a percentage of the property's value is the lender's headline measure of risk. A larger deposit lowers this ratio and typically unlocks lower rates in bands. The practical consequence is that the last increment of deposit that crosses a band boundary is worth much more than the increments before it.
Affordability testing
Lenders do not simply check that today's payment fits today's income. They assess committed outgoings, the stability of the income, and whether payments would remain sustainable at a higher rate than the one being offered. This is why borrowing capacity can fall even when a household's income has not changed: the test moved, not the applicant.
The costs that are not the rate
- Arrangement or product fees, which can be paid up front or added to the loan, in which case they attract interest.
- Valuation and legal fees connected to the lending rather than to the purchase itself.
- Early repayment charges during a fixed period, which matter to anyone who might move or refinance.
- Insurance requirements attached as a condition of the loan.
Comparing two offers on rate alone is unreliable, because a lower rate with a large fee can cost more over a short fixed period than a higher rate with no fee. The comparison that means something is the total paid over the period you actually expect to hold the loan.
This page explains how mortgage arithmetic works in general. It is not financial advice, no product is recommended, and the figures used elsewhere on this site as worked examples are illustrative arithmetic rather than quotations.