Download A guide to mortgages. Before you begin hunting for a property, it`s

A guide to mortgages.
Before you begin hunting for a property, it’s important to have a good idea of your realistic
maximum price – your cash deposit plus mortgage loan. Lenders use two methods to assess how
much they are prepared to lend you:
Income multiples.
This is the traditional method and until recently was the only means of assessment. The lender
works out the maximum loan they could offer you by multiplying your income by three or four
times. However, some lenders will now offer your five or six times your income.
Affordability.
Your income and outgoings are assessed to determine the maximum loan you could afford. Lenders
generally have a figure of about 20% of take-home income in mind.
Affordability in terms of income is only part of the story and all lenders will lend you more if you
have a bigger deposit. If you are borrowing 100% of the purchase price, the lender will want to be
quite sure you have enough income to keep up your repayments. However, if you have paid half the
cost of the property yourself, they will be more flexible. This is because they know that your desire
will be much stronger to keep paying your mortgage , if you got into financial difficulty.
A further factor is that the best lending terms are usually offered on mortgages with a maximum of
70% of the valuation (known as “Loan-to-Value” or LTV). With many properties in the South-East
now priced from £150,000, getting together a deposit of £45,000 to qualify for an 70% mortgage is
quite a challenge.
To work out how much you can borrow, the best way is to contact a mortgage broker. Alternatively
you can get a rough idea with a mortgage calculator: http://www.fsamortgagecalculator.co.uk/
Now that you know your price level, it’s time to start hunting for your new home.
Once you have found a property, the next step is to take advice to determine which lender is most
appropriate for you. This can mean the difference between a successful mortgage application and
being turned down. Using a broker can help you find a better deal. They will search the whole of
the market to track down the right deal with the right conditions for your circumstances.
Generally, there is a choice between an interest-only mortgage and a repayment mortgage.
However, following the credit crunch, interest only mortgages are harder to get and usually
require a big deposit.
With an interest only deal your monthly mortgage payment only covers the interest you owe on the
loan – you don’t pay off any of the loan itself over the course of the loan term. This means that you
need to put into place a means of saving up a lump sum by the end of the term.
A repayment mortgage also requires you to pay off the interest each month, but in addition every
month you will also pay off a portion of the money you borrowed. The lender will calculate these
payments to ensure that the whole amount of the loan is paid off at the end of the mortgage term,
so you don’t need to set up a separate savings plan with this type of mortgage
If your income increases over time, you may be able to make overpayments to reduce the amount
you owe and even to pay back the entire loan early (although this may incur a penalty charge).
Overpayments can be either regular monthly amounts or lump sums, so you could consider using an
inheritance or the lump sum from a maturing investment. Not all mortgage lenders offer an
overpayment facility, so you should check this at the outset.
The next thing you need to decide is what sort of deal to go for – fixed or variable rate.
Most mortgages have an introductory period, where you can choose to be charged interest at a fixed
rate or a a discounted variable rate. Many offers of both types are available so talk your options
through with a BROKER.
Fixed rate mortgages can be best if interest rates rise. Until the 1990s, most mortgages were
variable, but many homeowners suffered so badly from soaring mortgage rates in the early 1990’s,
that fixed rate mortgages started to grow in popularity.
The real boom started after 2000, when interest rates fell to 40-year lows. In recent years, the
proportion of new mortgages secured at fixed rates has sometimes been as high as 50%.
In the UK, the term of a fixed rate offer is rarely longer than 5 years. The mortgage loan itself may
last longer, but the lender will only fix the rate for a shorter period. In fact, most fixed rate loans are
for a period of 2 or 3 years.
Unless it is clear that interest rates are on a rising trend, the difference in cost of a variable rate
mortgage and a fixed rate mortgage over a two year period won’t be very much. If interest rates rise
and stay high, you will not have saved yourself from much of the pain with a short-term fix. So if
security of outgoings is important (perhaps your payments really are the absolute maximum you can
afford) then a longer-term fixed rate loan may be advantageous.
All lenders set their own mortgage lending rate, call their Standard Variable Rate (SVR). This is the
normal rate you pay once your introductory offer period has finished.
Lenders decide what they will charge as their SVR, depending on the Bank of England base rate,
which is the lowest rate at which anyone will lend money. The SVR is typically 1.3% to 4% above the
base rate.
It is worth noting that the lender has no obligation to keep the SVR in some specific relation to base
rate. In other words, if base rates rise, the lender is free to raise its SVR by more than the rise in
base rate, if the base rate falls lenders don’t have to cut their SVR by the same amount.
Discounted variable rate mortgages.
Many lenders offer a discount for an introductory period – usually 2 or 3 years. The discounts can be
substantial and such offers have been popular.
The most popular innovation in the mortgage market in recent years is the Tracker, where the
interest rate tracks the base rate. The usual formula for a tracker mortgage is ‘base rate plus x%’.
Long-term trackers are available – some lasting for the life of the mortgage.
It is the low base rate in recent years that has made this type of mortgage popular. However, if for
any reason interest rates were to become volatile again, this type of mortgage would see more
frequent changes in interest rates. Lenders are not bound to change their SVR every time the base
rate changes, but the rate on a tracker mortgage must follow the Bank of England base rate.
Capped rate mortgages.
These rate mortgages are loans at a variable rate of interest – but with a guarantee that the e rate
will not rise above a certain level (the cap). The cap lasts for a period of up to 5 years.
Usually the initial rate payable is higher than on a tracker or discount mortgage, so you pay
something for the ‘insurance’ built into the capped rate. They give you some of the benefits of fixed
rate loans, but with the advantage that if interest rates fall instead of rising, you still benefit.
Case Study 1:
fixed rate for security.
John Smith is a 31-year old solicitor. He recently got a job in London and anticipates being there for
several years. He is buying a flat for £250,000 with a £190,000 mortgage, obtained via a lender
which offers higher loans to members of professions such as law or accountancy.
John will be using almost 30% of his take home income on his mortgage repayments, and his
mortgage broker has pointed out that a 1% rise in interest rates would add over £150 per month to
his repayments. Together they conclude that a fixed rate mortgage would be advisable, at least for a
few years.
John’s broker finds he can secure a fixed rate for three years at 1% more that the lowest rate
available on a variable rate discount mortgage. John decided it is worth paying extra for the security
of fixed repayments for three years.
Case Study 2: variable rate for flexibility.
Carol Jones is an assistant marketing manager at a promotions company in Hertfordshire. She has
inherited £50,000 from her grandmother and is using it as the deposit on a flat for which she will pay
£200,000.
Carol is not sure how long she will stay in the job and may move away from the area. So she does
not want any long-term mortgage commitments. She is happy with the idea of letting out the flat if
she does decide to move.
The repayment on her £150,000 loan will be well within her means and she does not expect interest
rates to rise by much. Therefore Carol decides to go for the lowest cost with a discount tracker
mortgage over a two-year period. It offers an interest rate of base rate plus 3% for two years,
followed by SVR She will review her situation again when the introductory period ends. Since there
are no penalties at this point, she will be free to switch lender if she wants to.
On top of the mortgage types already discussed, there is another set of options provided to
borrowers. These options concern the management of your mortgage and the way it fits into your
lifestyle.
They are:
Flexible
Offset
Current Account
We previously mentioned the benefits of making overpayments.
Another way that you might want flexibility with your mortgage is the options to miss payments
(‘payment holidays’). If your income is erratic, or your circumstances change, this can be very
valuable. However, with some lenders even a single missed payment can lead to default notices and
black marks on your credit record.
In recent years lenders have evolved products that incorporate varying degrees of flexibility.
Depending on your lifestyle, it may be worth looking for lenders who offer the following mortgage
types.
Flexible mortgages are where:
The lender will accept additional payments into the account. They also calculate interest daily,
which means that such payments reduce interest costs from the day you make them. Most flexible
mortgages also allow you to take payment holidays if you have already overpaid into the account,
but, there are normally restrictions.
Offset mortgages are where:
With an offset mortgage, you set up a savings account with the lender. Instead of receiving interest
on the money in the savings account, it is deducted from the mortgage balance in calculating the
interest that you owe. This is advantageous because of tax.
If you had a balance of £20,000 in your savings account, on which you earned 2% net and you had a
mortgage on which you paid 4% offsetting means you no longer receive the £400 in annual interest,
but you also pay £800 less interest on your mortgage. The deal works even better for higher-rate
taxpayers (lose £300 and gain £800).
Most offset mortgages also allow overpayments and payment holidays. Some work on the basis that
you can always borrow up to the maximum initial loan, even if you have repaid a large part of it,
which is like having a giant overdraft facility secured against your home.
Current account mortgages are where:
All your personal borrowings are combined in one loan and all your payments (salary, bonuses, etc.)
go into the current account. When a payment reaches your current account you no longer pay
interest on that sum. So even though your salary is mostly spent during the month, the amount
that’s in the account still saves you interest on the mortgage for the time it’s there. It requires
considerable discipline to manage this type of account, although, there is no doubt it can have
significant benefits.
Both offset and current account mortgage come into their own if you have large savings that you
don’t want to sink into your property, or if you expect to have chunks of capital flowing in and out of
your account. The self-employed, with the need to accumulate cash for tax and VAT bills, can
especially benefit. However, the interest rates charged on offset and current account mortgages are
usually a notch above those on less flexible loans. So you need to be sure that you would use and
benefit from the extra flexibility.
Flexible mortgages, on the other hand, are now as keenly priced as many standard loans. If you get
if for next to nothing the extra freedom is worth having, even if you are not sure how much you
would use it.
Case Study 3: Flexibility can mean faster repayment.
Bob and Sue got married a year ago and are now buying a house together for £235,000 with a
£180,000 mortgage. Sue has a full-time teaching job but Bob is a self-employed IT contractor and his
income varies, with sizable lumps sums coming on the completion of projects.
At their current rate of earning, they expect to be able to overpay their mortgage, aiming to pay it
off in 20 years rather than 25, but not on a regular monthly basis. They decide with their broker that
they need a flexible mortgage. This will allow them each month to choose to pay more in if they can
afford to and have it immediately applied to the loan to reduce the interest. The idea of payment
holidays also appeals to them in case there are gaps in Bob’s income.
They find they can secure a flexible discount variable rate loan at 3% above the base rate for a 2 year
period. At the end of the introductory period the loan reverts to SVR, but they will be able to switch
to another lender, if they wish, without penalties.
The UK mortgage market is constantly changing. The most notable change in the recent past has
been the credit crisis. The number of mortgage offers available has declined and self certified and
adverse status (sub-prime) loans have virtually disappeared.
Is there a high arrangement fee?
Arrangement fees for loans have been rising sharply. A few years ago, an arrangement fee of over
£300 was unusual, but today many loans come with arrangement fees of £1000 or more. You can
sometimes add the fee to the loan, but if you are going to pay interest on it for 25 years this is not
always such a great idea. A big fee can mean that what looks like a good deal in terms of interest
rate isn’t so good after all. A good mortgage broker can work these sums through for you.
To avoid the higher lending charge (HLC).
If your deposit is small and this is often the case for first-time buyers, loan-to-value (LTV), or the
proportion of the total property value that you need to borrow, is often a major issue. You may only
have a small deposit available.
However, the best mortgage deals are usually ones with a maximum LTV of 80%. If you are
borrowing over 90% of valuation, watch out for a higher lending charge (HLC). This is basically an
insurance premium that pays out if the lender loses money on the property – you get no benefit
from it at all. Do everything you can to avoid HLCs – work out the numbers with the help of your
adviser, and you will discover that it can even be worth borrowing a few thousand elsewhere in
order to avoid the cost of and HLC.
Use a broker for the life cover.
Most lenders encourage you to take out a life insurance policy with a ‘sum assured’ at least
equal to what you owe them. In most cases this is sound financial planning, because it
protects your partner and any children.
If you have a repayment mortgage, you can choose a ‘mortgage protection’ policy which is where
the sum assured declines every year (because you have paid off a bit of the capital and owe less).
This costs less than a level term assurance policy where the sum assured remains the same. But if
you have an interest-only mortgage, you probably need a level term policy.
You can also add ’critical illness’ cover to a term assurance policy. This means that the sum assured
is paid if you are diagnosed as suffering from any one of a number of defined life-threatening
illnesses. Becoming mortgage-free, or at least having a cash sum in these circumstances, is
obliviously desirable in terms of stress and lifestyle.
The golden rule is not to buy life assurance from a mortgage lender or other tied agent. They sell
the policies of only one or a few companies and the cost of cover bought in this way can be above
what you could pay if you use an independent financial adviser (IFA). As well as advice about life and
critical illness cover for your family, an IFA can advise on income protection and unemployment
cover.
Your mortgage checklist.
Gimmicks aside, the bottom line for mortgage loans is simple:
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What is the interest rate?
For what period is it set?
What is the LTV
What are the lender’s criteria for maximum loan (income multiple or affordability)?
What are the fees?
Do they last after the introductory period ends?
Are there penalties for paying back early?
Evaluate offers on this basis, pick the brains of your mortgage adviser and you will soon find the best
deal for you.
Do you understand the jargon?
Affordability.
A method used by lenders to decide how much they will lend you, based on your actual incomings
and outgoings.
Arrangement fee.
The initial fee paid to the lender when a loan is agreed
Bank of England Base Rate.
The market-setting interest rate, review each month by the Bank of England and adjusted in order to
keep inflation in its target zone (around 2%).
Capped.
A variable-interest mortgage where the rate charged cannot rise above a set rate during a specified
period.
Chain.
A connected set of property transactions where C cannot buy from B until B has bought from A.
Completion.
The final stage of a property transaction where the legal ownership changes.
Conveyance.
The process of transferring legal ownership of a property (usually conducted by a solicitor).
Current account.
A type of mortgage where all your debts are secured against your home.
Deposit.
The lump sum which you are able to put towards the purchase price of your property.
Discount.
A type of mortgage where the interest rate is discounted for an introductory period.
Early redemption penalty.
A penalty charge if you re-pay or transfer a loan early. After an initial period, most variable-rate
loans today are penalty-free.
Equity.
Your stake in the value of a property. If the property is worth £200,000 and the mortgage is
£180,000 your equity is £20,000.
Exchanging contracts.
A binding commitment to buy/sell a property.
financial penalties.
Withdrawal after exchange incurs substantial
Fixed.
A mortgage where the interest rate is fixed for a set period.
Flexible.
A mortgage where interest is charged daily and where capital overpayments are allowed.
Guarantor.
A person who takes on the responsibility of the income and capital repayments of a mortgage if the
borrower defaults.
Higher Lending Charge (HLC).
A charge levied by the lender to insure itself against a loss on repossession and sale of the property.
Income multiple.
The conventional method used by lenders of calculating the maximum mortgage loan, based on the
amount of your salary.
Income protection.
A type of insurance policy that guarantees to pay a fixed monthly payment in the event of your
inability to work through illness. This will help to keep up your mortgage payments.
Interest only.
A mortgage where the capital is only paid back at the end of the term.
Joint mortgage.
Two or more purchasers are named jointly as borrowers. In the normal joint mortgage, if one party
defaults the other(s) becomes liable for the whole loan.
Legal fees.
Legal fees for arranging a mortgage are often waived if the lender’s solicitor uses your solicitors.
Loan-To-Value (LTV).
The maximum percentage of the property value that a lender will advance with a particular
mortgage offer.
Mortgage Payment Protection Insurance.
A type of insurance that ensures your mortgage payments are met if you are made redundant or are
unable to work through illness. Policies sold by lenders are usually very poor value.
Mortgage Protection Assurance.
A type of term assurance where the level of cover reduces over time, in line with the reducing
balance owed on a repayment mortgage.
Negative Equity.
If the value of your home falls below the value of the outstanding mortgage, the difference is your
negative equity.
No-fee broker.
A mortgage broker who receives payments only from mortgage lenders and does not charge fees to
borrowers.
Offset.
A type of mortgage where a borrower’s savings are offset against the amount borrowed.
Overpayment.
Payments greater than those required to repay a mortgage on its original schedule, made with the
intention of shortening the mortgage term.
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Payment holiday.
A period of months in which a borrower with a flexible mortgage may skip payments.
Repayment.
The original type of mortgage, where monthly payments consist of a combination of interest and
capital.
Repossession.
When a borrower defaults, a lender may repossess the property – but only through the courts,
which will rarely allow repossession if the property is occupied by a parent with dependent children.
Self-certification.
A process whereby a borrower certifies his income without providing evidence to the lender.
Stamp duty.
Stamp Duty Land Tax: payable by the purchaser at 1% of the total value for properties worth
between £125,000 and £250,000, 3% on those valued at up to £500,000 and 4% on properties worth
more than £500,000. Only properties worth less than £125,000 avoid paying Stamp Duty.
Standard Variable Rate (SVR).
A lender’s normal interest rate on mortgages.
Survey.
A full structural survey involves a thorough investigation of a property; a lower =cost survey provides
no guarantees that defects have been identified.
Term.
The period up to the redemption of a mortgage.
Term assurance.
Life assurance for a fixed period of years, usually required by mortgage lenders to cover the amount
of the loan if the borrower has dependants.
Tracker.
Mortgage where the interest rate charged moves in line with the Bank of England Base rate.
Valuation.
Surveyor’s independent valuation of a property. Surveyors valuing a property on behalf of a lender
will usually value somewhat below current market value.
Variable.
Mortgage where the interest rate charged may vary from month to month.
Whole of market.
Mortgage broker who can give you advice on all lenders, rather than a restricted selection.