Economics of Mortgages

What is a Mortgage?

Mortgages are a particular type of loan, useful for the purchase of a house. The loan is secured against the value of the house.

Average house prices in the UK are close to £200,000. Average incomes are, by comparison, £23,000 a year. Clearly, the average worker would be unable to buy a house without the help of a mortgage.

Banks and building societies are able to offer high mortgage loans because they can maintain the house as security. Basically, if you default on your mortgage payments the building society can repossess your house. We say this type of loan is a secured loan. Without the security of the asset, mortgage loans would not be possible.

Repayment of a mortgage.

A building society profits from giving mortgages because it can charge interest over the term of the mortgage payment. Suppose you borrow a £140,000 mortgage to buy a house. If the term is fixed at 30 years, and interest rates average at 6%. This is the amount of interest and capital you are likely to repay.

  • Monthly repayments £839
  • Total Repayment £302,174
  • Total Interest £162,700

Therefore, over the course of the 30 years you end up paying more than double the initial mortgage term. This is how the bank makes profit. But, it also enable you to buy a house, you wouldn’t be able to through saving.

The importance of Interest Rates on Mortgages.

Monthly repayments on a mortgage depend upon

  1. The amount that you owe
  2. The interest rate.

Interest rates are set by the Monetary Policy Committee and are used to control inflation. Therefore, the mortgage interest repayments can easily change from month to month. For example, in the past 12 months (July 2007) the MPC have increased interest rates 5 times. This is to combat rising inflation pressures in the economy.
Therefore, when you take out a mortgage, you have to be aware that the cost could increase significantly in the future, should interest rates rise.

For example, in 1992 UK interest rates reached 15% causing widespread mortgage defaults.

See: Effects of Interest Rates on the UK economy