What is a remortgage and how does it work?

In today’s article we will look at the topic of remortgage, also known as a mortgage switch. You’ll find out what the whole process is about, when it’s worth going for it and what affects how much you could save. We hope this post will help you make better decisions about your mortgage.

What is a remortgage?

In simplest terms, remortgaging in the UK involves taking out a new mortgage to pay off your previous mortgage. Importantly, remortgaging can either take place with the same bank or involve moving to a different mortgage provider - it all depends on the current offers on the market.

What is a remortgage for?

Refinancing a mortgage has one obvious purpose - it’s about money, or more specifically, getting better repayment terms. Switching to a lower rate can reduce your monthly payments, but how much you could save depends on your loan balance, your property’s value, your current and new rates, and any fees.

How does a remortgage work?

Many mortgages start with an initial deal period, often two or five years. When it ends, your rate usually changes to the lender’s reversion rate, often its standard variable rate (SVR), which is normally higher.

In practice, remortgage works as follows: after 2 years, the interest rate freeze on your mortgage ends, causing your instalments to increase by a notional 30%. However, it turns out that a competing bank can offer you a better product which, although still more expensive than your existing mortgage, is cheaper than the new offer made by your current mortgage provider. In that situation, switching to the other lender may save you money once any fees and early repayment charges are taken into account.

Remortgaging with a new lender involves a process similar to your original application, including affordability checks. Switching to a new deal with your current lender is often simpler.

Why can I get a lower interest rate with a remortgage?

Another lender may offer you a lower rate than your current one for several reasons. The main ones are below.

LTV ratio

The loan to value (LTV) ratio determines the proportion of the amount borrowed to the value of the property. If you took out your mortgage with a 5% deposit, the LTV at the outset was 95% (100% - 5%), whereas when the deposit was 10%, the loan to value ratio was obviously at 90%.

Note that with each instalment, the home you repay becomes more and more yours - the amount of the commitment decreases. As you repay your mortgage, and if your property’s value rises, your LTV falls. Moving into a lower LTV band (for example from 95% to 90%) can give you access to lower rates.

Why can a lower LTV mean a lower rate? Because the bank’s risk is reduced. In a situation where you would not be able to pay the mortgage instalments and your property would have to be repossessed and sold, there is a much greater chance of the creditor (the bank) being fully satisfied when the property is much more expensive than the mortgage itself. Lenders see a lower loan-to-value (a larger deposit or more equity) as less risky, so the lower your LTV, the lower the interest rate you are likely to be offered.

Competition between banks

You have to remember that banks are businesses, exactly like insurance companies, supermarkets or computer manufacturers. Every company wants as many customers as possible and it often pays to offer a slightly lower price to attract them. Mortgages also come with promotions. Lenders set their own rates, so it is worth comparing deals from other lenders with your current lender’s offer.

Your creditworthiness

There is a good chance that over time, your affordability has increased. This could have been as a result of a change of job or a pay rise, a reduction in other commitments or a number of other factors that have positively impacted your image in the eyes of the bank. Your credit score may also have improved if there have been no defaults on your payments for a long time. A higher income and a clean recent credit record can make lenders more willing to lend to you, subject to their affordability checks and criteria.

What does a remortgage affect?

Lower interest rates are not the only advantage of remortgaging - various credit terms and conditions are subject to change. Moving your mortgage is a great opportunity to shorten or extend the term of your finance or make an overpayment with money from, for example, an inheritance. In doing so, note that if your new rate is lower, your instalment may fall, so you may be able to shorten the repayment period by a year while paying about the same amount, and repay your mortgage sooner.

Remortgaging is also a way of borrowing extra cash. For example, you may be able to borrow more by remortgaging, subject to the lender’s affordability checks and criteria, to buy yourself a car or carry out an extension to your home. Borrowing more increases the debt secured on your home, and spreading it over a long mortgage term can mean paying more interest overall. If you own a shared ownership home, you may be able to remortgage to raise money to buy more shares in it (staircasing) and so own more of your home. Whether and how you can do this depends on your lease and your housing provider’s rules, on the new lender’s criteria and on a valuation, usually by a RICS-registered surveyor.

When does a remortgage pay off?

The answer to this question is not simple. First of all, it is advisable to contact a credit advisor from Extend Finance, who will take all the circumstances into account and simply calculate it.

In principle, remortgage pays off when:

• Interest rates are at a lower level than when you originally borrowed the money;

• The current fixed-term mortgage contract is coming to an end;

• You want to borrow more and the mortgage rate available to you is lower than other borrowing options, bearing in mind that a longer term can mean paying more interest overall and the debt is secured on your home;

• The savings from it exceed the Early Repayment Charge, if applicable.

There are times when a remortgage will not be viable for you. This can be the case when your current rate is lower than the deals now available, or when an early repayment charge would outweigh the savings. In such situations, it is definitely worth holding off on changing banks, although we recommend that you monitor the market situation regularly - offers change on a basically daily basis.

What needs to be taken into account when remortgaging?

Before you make your final decision on a new mortgage, remember to:

• Contact a credit counselor who will take care of finding the best-fit offer for your needs;

• Take into account the new lender’s fees, such as an arrangement (product) fee, valuation fee and legal fees. If you add a fee to your loan, you will usually pay interest on it, so the total you repay can rise;

• Take into account possible penalties for early repayment of the existing mortgage - the Early Repayment Charge. Information about these can be found in your mortgage offer documents, but you can also contact the bank directly;

• Consider using savings to reduce the amount you borrow when you remortgage. This lowers your loan-to-value, and if it moves you into a lower LTV band, you may be offered a lower interest rate;

• Potential savings - compare the total cost of each option, including fees, to check whether switching is worth it for you.

Mortgage overpayment through remortgage

Depending on your lender, an overpayment may reduce your monthly payment or shorten your mortgage term. Fixed and discounted deals may limit how much you can overpay each year without an early repayment charge, so check your mortgage terms. Remortgaging at the end of a deal can be a chance to pay a lump sum off your balance.

Admittedly, remortgaging involves additional costs, so weigh them against what you would gain from a lump-sum payment, but if you’ve recently received an inheritance, severance or other large cash injection, it’s definitely worth talking to us.

We hope we have answered many of your questions and you have a much better understanding of how the mechanisms behind remortgaging work. If you’d like to further expand your knowledge, we encourage you to read articles about UK mortgages and the property buying process as well as other content on our blog.

As always, we also encourage you to get in touch. We can help compare the mortgage options available to us, taking account of costs and your circumstances. Approval and terms depend on the lender.