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Mortgages Guide
What is a mortgage?
A mortgage is the name given to a loan secured on your home. It is usually used to buy the home although it is becoming more popular to consider a new mortgage, where the propety is already owned, to access a more competitive mortgage product or to raise capital for other purposes, such as school fees, business investment or buy to let.
A mortgage is a long-term loan and traditionally have run for a fixed period, typically 25 years. However, most mortgages are flexible enough to allow for early repayment or, if your circumstances dictate, the term can be extended beyond the original loan period.
Mortgages were once the preserve of building societies and the high street banks, however recently far more competition has entered the market and there is now a raft of lenders offering mortgage loans on residential property. This expansion in the number of lenders has lead to a vast array of different loan packages.
Nowadays there are loan deals to suit most people's needs, whether you are buying your first home, a retirement cottage or perhaps an investment property.
You should note that in year 2000 the Government removed Mortgage Interest relief (tax relief) on mortgage interest. Although it is still possible to invest into tax efficient savings or investment plans to assist you repay your mortgage at the end of its term.
What different types are there?
Although there are many different mortgage deals on the market, generally they can be split into three basic types:
Repayment mortgage: Under these arrangements you are required to make monthly payments wich are made up of part capital and part interest. Payments often remain the same across the term of the loan. The structure of the repayment method normally means that during the early years of the mortgage, little capital is repaid. The rate of repayment accelerates over time.
Repayment mortgages are normally quite flexible as it is sometimes possible to extend the term of the loan but only with the written permission of the lender. Also, it is normally possible to increase the capital repayment of the loan so decreasing the term, allowing you to repay your debt early.
Interest only: These arrangements do not require that you make capital repayments until the end of the loan. The monthly payments to the lender are made up entirely of interest on your outstanding debt.
In order to clear capital, at the end of the loan term, you must have an amount equal to the outstanding debt. Most people achieve this by making regular contributions to a savings plan; this plan is targeted to accumulate an amount sufficient to repay the outstanding debt at the end of the mortgage term. Any such savings plan (e.g. Endowment Assurance or ISA plan) should be kept under regular review.
Flexible: These are a newer style of mortgage arrangement. They offer you the option to increase or decrease your monthly payments (and sometimes even the opportunity to stop them altogether for specified periods. This flexibility is designed to assist you to manage your cash flow. Many flexible mortgages offer daily or monthly calculation of interest. This system could normally be expected, when compared with a more traditional mortgage, to reduce the overall amount of interest you pay throughout the loan term.
The latest addition to the mortgage range is a combined system of current, savings and mortgage accounts. The mortgage element will still be a repayment, interest only or flexible loan, but the amount of money in your current and/or savings accounts are taken into account considered when the lender calculates the interest due on your mortgage.
For example if you hold a savings account with a balance of £1,000, this amount will be considered by the lender when calcualting the interest due by effectively reducing the total mortgage by a amount equal to you savings. Such arrangements are known as offset mortgages.
You may also find a ‘drawdown’ mortgage, which is helpful if you have a property that requires renovation. You receive a basic amount, but as you complete renovation work on your home, further amounts become available for you to draw down as and when required.
Further differences occur in the way interest is calculated on your mortgage.
Variable: the interest rate you pay rises and falls in line with the bank base rate.
Fixed: the interest rate is fixed for a given time at the start of your mortgage normally from 1 to 5 years although this can be longer. Note that you may have to pay a higher interest rate when the fixed period finishes.
Discounted: the lender gives you a discount on its standard variable rate for a given time.
Capped: the interest rate is guaranteed not to rise above a certain percentage, but it may also have a ‘collar’, i.e. it will not fall below a certain rate.
Different lenders will offer you different incentives to take out a mortgage with them, for example:
Cashback: on completion of your mortgage, you will receive a cash lump sum.
a payment of some or all fees: the lender provides you with an allowance to cover the cost of things such as survey, legal fees, or may even meet the stamp duty charges
Please note where immediate offers such as these are provided it is common for lenders to charge you a penalty should you repay your mortgage during the early years of its term.
What should I think about when choosing a mortgage?
To assist you to narrow down the search for your new mortgage, you should first decide which payment method best suits you. Whether it is to be a repayment, interest only or perhaps a flexible mortgage. To help you decide on the method most suitable for you, it would be sensible to take into account your attitude to risk . Only a repayment mortgage can guarantee, assuming all mortgage payments are maintained properly, that your mortgage debt will be repaid at the end of the original mortgage term.
Always shop around for the best rates, but be sure you are comparing like with like. To do this check the APR of the loan. You also need to bear in mind that the interest payments in respect of fixed rate mortgages can rise steeply once the initial 'fixed' period ends. Therefore your planning should always include the possibility of sharp changes to future interest payments. Use a mortgage Calculator to check on the monthly repayments.
If you are intending to sell your home in the near future, check whether there are any redemption penalties attached to the mortgage or if your mortgage deal will allow you to take the mortgage on to the next property.
Check what arrangement fees the lender charges and whether these are refundable should you decide not to proceed midway through the application process.
Check for additional costs such as mortgage indemnity premiums and buildings and contents insurance. Consider using a mortgage broker and taking independent financial advice, this site offers both, this can save you a lot of time checking the differences between the various lenders; it can also help clarify which mortgage package best suits your circumstances.
More information on interest only mortgages
If you elect to have a interest only mortgage then your payment to the lender only represents the interest due on the outstanding debt. In order to repay that debt then normally you would use an additional savings vehicle. One that enables you to build a fund of money from which you can clear the mortgage at the end of the agreed term. The lender may also expect you to have sufficient life assurance cover to enable your next of kin to repay the debt if you die during the term of the mortgage.
The three most common savings vehicles used for mortgage repayment are:-
ISA: you can benefit from the tax concessions available within these plans. Under current legislation any income or gains achieved from your ISA plan are tax-free. It is from the proceeds of your plan that pay off your mortgage. An added opportunity, if your ISA performs exceptionally well, or you can afford additional payments to it, is that you may be able to repay your mortgage ahead of schedule.
Pension: by using the tax-free lump sum facility available from your pension plan to pay off your mortgage debt, you can take advantage of the tax relief that are availble on pension contributions. You must remember that under normal circumstances the benefits under pension plans may not be drawn before age 50. Therefore the earliest likely date at which you could repay your mortgage debt would be 50.
If pension benefits are provided by your employer, these cannot normally be taken until you actually retire from that employment. According if you are looking to pay off your mortgage earlier than when you retire then a Pension may not be the appropriate repayment vehicle for your needs.
Since part of your pension fund is being used to clear the mortgage debt, you should be aware that your income in retirement will reflect this fact as less money will be available for the provision of income. Careful consideration needs to be given to this repayment method. You would be wise to seek advice from your financial adviser before adopting this approach.
Endowment: These are Life Assurance policies that serve two purposes. Firstly they provide financial protection in case you die before the end of the mortgage term. Secondly, if you survive throughout the policy term,the investment element of the policy provides a lump sum (maturity value) that can be used to repay the outstanding mortgage debt.
The use of these arrangements has been very popular in the past but has received negative press coverage during in the 1990s. There is some suggestion that many of the problems were associated with poor advice when homebuyers first took out the endowment policies along side their mortgage loans. It must be understood that endowment policies are long-term investments, the value of which may rise and fall in line with the stock market. However over 25 years, they may yield more than the amount you need to pay off your mortgage although there are no guarantees available.There are three types of endowment policies:
With profits: you share in the profit of the life company through which you buy the policy. This profit is added to the amount in your funds
Unit-linked: the value of your units rise and fall in line with the underlying funds into which your money is being invested
Unitised with profits: a new version of the traditional with profits concept that provides the ability to value the policy quick and allows the charges to be specified and collected in a similar manner to a unit linked plan.
Please note that none of the above methods are guaranteed to repay your mortgage at the end of the mortgage term.
How large a mortgage can I have?
Three factors determine the size of mortgage you can have:
The deposit you pay on the house: a lender would usually expect you to put down at least 5% of the purchase price of the house, though some lenders will consider a 100% mortgage
Your salary: generally, you can have a mortgage equivalent to 3 times your salary. If you have a joint mortgage, you could apply for 2.5 times your combined salaries, or 3 times the main salary, plus the second salary.
The amount of any existing commitments you have: the amount of personal loans, hire purchase agreements may be deducted from the amount available for you to borrow.
The lender will expect to see proof of your salary and will write to your employer for confirmation. If you include commission or bonuses in your salary amount, the lender would expect confirmation from your employer that these are regular payments. However, if you require a mortgage of less than 75% of the value of the property, the lender may allow you to self-certificate your income.
What are mortgage indemnity payments?
If you take out a mortgage for more than 75% of the value of your home , the lender will normally ask you to provide additional security to cover their potential loss should default on the loan. The most common method of providing this additional security is for the lender to affect an insurance policy (the premiums for which will be pay for by you). The lender uses the money received from the insurance policy to cover the costs they suffer involved in the repossession and resale of the property.
Please note that after any claim the insurer will normally look to recover, from you, any payments they make to the lender. The amount they will try to recover would include any legal fees they have suffered during the process.
What other costs are involved when buying a house?
In addition to your mortgage, you should bear in mind the following one-off costs at the time or purchase (or remortgage if you are changing mortgage lenders):
Legal fees: unless you intend to carry out your own conveyancing, you will need to pay a solicitor or other suitably qualified person to complete the legal work
Land Registry fee: the Land Registry registers your ownership of the property
Searches: your solicitor (or you) will need to check to see if there are any plans for the neighbourhood which could affect the value of your property, such as the building of a new road
Survey and valuation: the lender will insist that a survey and valuation is done on the property. You should think about a more comprehensive survey to check for structural or other defects
Stamp duty: all transfers of property of £60,000 or over attract stamp duty. For property transfers between £60,000 and £249,999 stamp duty is charged at 1% of the property price, for properties between £250,000 and £500,000 then the rate is 3.0%. The rate of Stamp duty for transfers of property over £500,000 is 4%.
STOP PRESS: In his Pre-Budget Report of 27 November the Chancellor of the Exchequer announced his Government's intention to implement the first phase of the stamp duty exemption relating to the purchase of property in certain designated disadvantaged areas of the UK, which will apply where the consideration, or premium for a lease, does not exceed £150,000. Relief will be available for all transfers of property in the designated areas with effect from 30th November 2001. |
