Homes / Mortgages

What is a mortgage?
A mortgage is the name given to a loan secured on your home.  A mortgage is a long-term loan and, traditionally, has a run for a fixed period, typically 25 years.  However most mortgages are flexible enough to allow for early repayment or, if your circumstances allow, the term can be extended beyond the original loan period.

A mortgage is usually used to buy the home although it is becoming more popular to consider a new mortgage where the property is already owned.  This is to get a more competitive mortgage product or to raise money for other purposes, such as school fees or a business investment.   For example people who have been in their homes for a number of years with an existing mortgage can get a new mortgage at a better rate.

Mortgages were once the territory of building societies and the high street banks.  Recently, however, far more competition has entered the market and there are now a huge variety 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.

(Please note that every mortgage is different and this is just a general overview of mortgages offered)

What different types are there?

• Repayment
• Interest Only
• Flexible/Variable
• Offset
• Fixed rate
• Capped
• Tracker
• Discounted
• CAT Standard

• Repayment Mortgage:

Under these arrangements you are required to make monthly payments, which are made up of part capital and part interest.  Payments often remain the same across the term of the mortgage.  The structure of the repayment method normally means that during the early years of the mortgage, little money 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.  This would allow you to repay your debt earlier.

(Please note that repayment mortgages can also be fixed, variable or capped)

• Interest Only Mortgage:

These arrangements do not require that you make money 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 debt that remains.  Most people achieve this by making regular contributions to a savings plan; this plan is targeted to build up an amount satisfactory to repay the outstanding debt at the end of the mortgage 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.

• Flexible/Variable Mortgage:
  
  You may be lucky enough to receive a financial windfall; maybe you want to take a break from your responsibilities.  A flexible mortgage allows you to pay off your mortgage early, make overpayments or pay in lump sums.

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 mortgage term.

• Offset Mortgage:

This latest addition to the mortgage range is a combined system of current, savings and mortgage accounts.  The mortgage aspect will still be a repayment but the amount of money in your current and/or savings accounts are taken into consideration when the lender calculates the interest due on your mortgage.

Let’s say you have £100,000 outstanding on your new mortgage and a total of £8,000 in your current and savings accounts. The interest you pay, with an offset mortgage, is on the difference between the two – in this case £92,000.

By reducing the interest payable, you could pay off your mortgage more quickly.  Or, if you prefer, you can reduce the monthly amount you pay instead. It’s that simple.

• Fixed Rate Mortgages:
   
  With a fixed rate mortgage there are no surprises, it is designed to offer you the security of a fixed interest rate for a fixed period of time.
  Budgeting and organising your finances can be complicated and confusing, but with a fixed rate mortgage you will have the certainty of a stable and unchanging mortgage payment.

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. 

The negative side to a fixed rate mortgage is that if you want to change your mortgage within the fixed rate period there are substantial penalties involved.

Please note that you may have to pay a higher interest rate when the fixed period finishes.

• Capped rate mortgages
  
  With a capped rate mortgage you will benefit from the security of interest rates that will not go above a certain level.  Should the standard variable rate fall below your cap then the interest rate you pay will also drop.
  
  This gives you control over external factors such as interest rates and will offer you peace of mind that your repayments will be affordable.

• Tracker mortgages

Our flexible tracker mortgages move in line with base rates. The rate is variable and is affected by changes to the Bank of England published base rate, so you know you'll always be in line with the market.

·         Discounted Mortgage:

The lender will give you a discount on their standard variable rate for a given period, normally one, two or three years.

·         CAT standard mortgage:

A CAT standard mortgage meets the requirements set up by the government for fair Charges, easy Access and decent Terms

To achieve the government’s mortgage CAT standard all fees must be explained from the beginning.  Interest must be calculated on a daily basis and the interest rate must be no higher than 2% above the Bank of England rate.

There are no early redemption charges for variable rate mortgages and redemption charges on fixed or capped mortgages can only be charged during the lower rate period at no more than 1% of the loan for the remaining years.  There is a maximum of £150 arrangement fee if the mortgage is capped or fixed rate.

There is no separate charge for mortgage indemnity insurance and no products can be tied in to the mortgage (such as buildings insurance).  The mortgage can move with you to another property and you can even choose the day of the month you want to make payments.  You can repay your mortgage earlier if you wish. 

Above all the terms must be fair, clear and not misleading.

What should I think about when choosing a mortgage?
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.  To do this you should check the Annual Percentage Rate of the loan. You also need to bear in mind that the interest payments in for 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.

If you are intending to sell your home in the near future, check whether there is a release penalty attached to the mortgage.  Also check if your mortgage deal will allow you to take the mortgage on to your next property.

Check what arrangement fees the lender charges and whether these are refundable should you decide not to carry on halfway 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 can save you a lot of time checking the differences between the various lenders.  A broker can also make clear to you which mortgage package best suits your circumstances.

There are three most common savings vehicles used for mortgage repayments:

• ISA:

You can benefit from the tax reduction available within these plans. Under the current law any income attained from your ISA plan are tax-free.  It is from the proceeds of your plan that you pay off your mortgage.  An added opportunity is that you may be able to repay your mortgage ahead of schedule if your ISA does well, or you can afford to put more money into it.

• 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 is available on pension contributions.  You must remember that under normal circumstances the benefits under pension plans may not be drawn before you reach 50.  Therefore the earliest likely date at which you could repay your mortgage debt would be at 50.

If your employer provides pension benefits, these cannot normally be taken until you actually retire from that employment.  If you are looking to pay off your mortgage earlier than when you retire then a Pension may not be the right 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 would reflect this fact.  This means 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 part of the policy provides a lump sum that can be used to repay the remaining mortgage debt. 

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 original funds into which your money is being invested.

Unitised with profits:       A new version of the traditional ‘with profits’ idea that provides you with the ability to value the policy quickly.  It also allows the charges to be specified and collected in a similar manner to a ‘unit linked’ plan.

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.

(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:

1.         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.

2.         Your salary.  Generally, you can have a mortgage equal to three and a half times your salary.  If you have a joint mortgage, you could apply for three times your combined salaries.

3.         The amount of any existing commitments you have.  The amount of personal loans and 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 and/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. 

I am self-employed.  How can I go about getting a mortgage?
If you can supply three years audited accounts and show a continuing good income trend, then most lenders will consider your application.

My income is erratic.  Does this mean I’m out of the running for a mortgage?
You can apply for a self-certification mortgage for up to 90% of the value of your property.  This means that you do not need to show proof of your income.  You should note that the interest charged on self-certified loans might be higher than if income is confirmed.  This is normally to reflect the supposed higher risk of lending to someone without proof of their 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 you fail to pay the loan.  The most common method of providing this additional security is for the lender to insist on an insurance policy (the premiums for which will be paid 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 about protecting my mortgage payments?
There are now very limited state resources for meeting mortgage payments.  It is sensible to look at insurance policies that pay out if you lose your job or are unable to work because of illness.  Mortgage protection insurance policies generally pay out up to 12 months’ mortgage payments.  They are frequently combined with other insurances such as critical illness or permanent health insurance.

(Check the details of your protection plan because most will not kick in until six months after redundancy)

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:

What if I can’t meet my mortgage payments?
Contact your lender as soon as you realise you have a problem.  Although your mortgage is secured on your home, lenders see repossession as the last resort.   They stand to make more money from your mortgage than the sale of your home.  Lenders will work out a plan with you to reduce your payments for a time or stop them temporarily, and work out a new term for your mortgage.