Mortgages

Understanding mortgages can be a minefield! Treading your way through it can be difficult.

To compare which mortgages are currently available see our Mortgage Comparison Table

Here are a few things you need to know before you start:

What type of mortgage?

There are 3 types of residential mortgage – Repayment mortgages, Interest Only mortgages (with repayment vehicle) and Interest Only mortgages (without repayment vehicle).

1. Repayment mortgages

  • You pay accrued interest and capital repayments
  • The amount you owe reduces every year
  • In the early years you are paying mainly interest so the debt will only reduce by a small amount – not ideal if you expect to move again soon
  • The mortgage will be paid off over a set term (typically 25 years).

2. Interest only mortgages (with repayment vehicle)

  • You only pay interest and have a plan to pay off the capital at the end of the term. Typically this would be an Endowment policy, a pension or an ISA, or some other vehicle that will build a pot of money sufficient to pay off the mortgage at the end of the term.
  • Most of these plans aren’t guaranteed to build a fund large enough to pay off the mortgage at the end of the term, being dependant on the performance of the stocks and bonds the Provider invests in. There is a risk that you will be unable to pay off all of the mortgage at the end of the term.
  • Dependant on your circumstances, repayment plans can be tax efficient although any decision on these should only be taken after taking specialist advice from a Mortgage Broker or Independent Financial Advisor (IFA).

3. Interest only mortgages (without repayment vehicle)

  • You pay interest only and rely on other assets to pay off the mortgage at the end of the term.
  • Alternatively, your plan could be to sell the property itself before the end of the term and use the proceeds to pay off the mortgage.
  • This is a higher risk strategy, as if property prices do not rise significantly – or even fall – over the term of the mortgage, you could have insufficient equity to repay the debt.
  • Interest only mortgages are mainly suitable for Investors (many Buy to Let mortgages are interest only) or those who are confident that other assets will be available to pay off the capital if required.
  • Many Lenders see these as too high risk and will only lend on an interest only basis where there is proof that a separate repayment vehicle is in place.

4. Offset mortgages

  • The principle of an offset mortgage is quite simple. Any savings you have are set off against your mortgage debt.
  • You forfeit any interest you would have received on your savings but you don’t pay interest on the same amount of your mortgage debt. This can enable you to pay off your mortgage early – possibly by several years.
  • Obviously the more you have in savings, the more you will benefit. At a time when the amount of interest paid on savings is likely to be lower than the interest rate on your mortgage, this can be very efficient.
  • You will also avoid paying tax on your savings.
  • Rates on offset mortgages used to be significantly higher than on other types of mortgages but this is not now always the case.

Interest Rate Options

The following options are normally available:

1. Fixed Rate

Typical example: 2%, fixed for 2 years, with Early Repayment Charge, and Arrangement Fee of £1,495

  • The rate of interest (and so your payments) are fixed for a set number of years usually between 2 and 5, regardless of what happens to Bank base rate.
  • At the end of the fixed rate term, the mortgage will usually revert to the Lender’s Standard Variable Rate (SVR).
  • SVR’s are often higher than Variable or Tracker rates, so it might be a good idea to remortgage onto an alternative loan at the end of the fixed term (although there is no guarantee that your circumstances – income, etc. – will make this possible.
  • Most Fixed Rate mortgages have an Arrangement Fee (which can be paid as a one-off, or added to the loan).
  • There will also usually be an Early Repayment Charge (ERC). This penalises you – often heavily – if you wish to pay off the mortgage early.
  • The ERC may apply even after the term for the fixed rate has ended. For example you might be offered a 2 year fixed rate with a 3 year ERC. This effectively forces you to pay their (higher) SVR for at least a year.

2. Variable Rate

Typical example: 6% over the whole term

  • The rate can vary at any time, dependant on the Lender’s policy and the changing market conditions. Rates could go up or down.
  • You have no control or certainty and at a time when Banks are risk averse, these can be expensive.

3. Tracker

Typical example: 2% above Bank Base rate for 3 years, with Early Repayment Charge, and Arrangement Fee of £995

  • Interest rates are linked to some other rate, usually Bank Base Rate (BBR) or London Interbank Offered Rate (LIBOR).
  • The tracker rate will be a % above the linked rate, and if the linked rate increases, the tracker rate will increase by the same amount.
  • Tracker rates can apply for the whole term of the mortgage. If they only apply for a specified period, the rate will revert to the Lender’s SVR after this.
  • Many Tracker mortgages have an Arrangement Fee (which can be paid as a one-off, or added to the loan).
  • There will usually also be an Early Repayment Charge (ERC) at the end of the Tracker rate period. This penalises you – often heavily – if you wish to pay off the mortgage early. ERCs do not usually apply where the rate applies to the whole term of the mortgage.

4. Discounted

Typical example: 2.5% discount to Lender’s Standard Variable rate for 2 years, with Early Repayment Charge, and Arrangement Fee of £1,995

  • The interest rate payable is the Lender’s SVR discounted by a set percentage, for a specified period of time.

5. Capped

Typical example: 2% above Bank Base Rate for 3 years, capped at 2.5% above Bank Base Rate for 3 years, with Early Repayment Charge and Arrangement Fee of £995

  • Similar to a fixed rate mortgage except that if rates rise, the mortgage pay rate is capped.
  • You benefit from rates falling but have some protection against rates rising.

IMPORTANT:

  1. Compare the real cost of each mortgage taking into account all fees. Lenders charge a range of extra fees in addition to Arrangement Fees – Valuation Fees, Processing Fees, etc.
  2. Take specialist advice. If you only talk to one Bank, you’ll only know what they can offer. If you talk to a Mortgage Broker, you’ll know what the market can offer.

To compare which mortgages are currently available see our Mortgage Comparison Table

Qualifying for a Mortgage

The mortgages (and remortgages) available to you will depend on your circumstances.

There are 5 main things that prospective Lenders take into account when assessing your suitability for a mortgage or a remortgage:

  • Your income (joint income if buying with a partner). Their calculations vary but most Lenders will allow a maximum loan size which is typically a multiple of your income.Regular income, not reliant on bonuses or overtime, is preferred to income that isn’t guaranteed from month to month.
  • Your outgoings. In recent years more and more Lenders have taken outgoings as well as income into consideration. This is logical – for example if you have a car lease payment to make each month then clearly you are less able to afford the same mortgage payment as someone who doesn’t have such a commitment.
  • Your credit record. When funds available for mortgage lending are restricted, or lending is perceived to be higher risk (perhaps because of flat or falling property prices), Lenders will be more selective and will require borrowers to have good credit scores.They see potential borrowers who have a history of missing loan or credit card payments as more likely to default on a mortgage, and with good reason.
  • Your deposit. A few years ago 100% mortgages were freely available.Unfortunately for anyone trying to climb the housing ladder now, those days are gone. Most Lenders now require a deposit of at least 10%.This gives them better security at a time of economic uncertainty.In addition to the size of the deposit, they are interested in the source – if you’ve saved it regularly over several years this demonstrates a responsible attitude to money that gives them confidence in your ability to repay their loan.The higher your deposit, the better (lower) interest rate you will qualify for. In the current economic climate, Banks are risk averse and their best rates are reserved for those with the highest deposits (40% or more). The higher your deposit, the lower the risk to the Lender, and so the lower rate they will offer.
  • The property. When Lenders can afford to be selective due to limited funds available for lending, they become more selective about the types of properties they will lend on.They might be reluctant to lend for new-build apartments (where in recent years values have often fallen dramatically) or ex-Local Authority properties.

How do you know which Lenders are likely to lend to you?

The best way to find out is to use an independent mortgage broker, i.e. one who is not associated or affiliated to one particular Lender.

A Mortgage Broker will have access to the whole lending market, as well as knowledge of each Lender’s individual criteria, and so can steer you towards those who are most likely to lend to you.

You should be very wary of using the in-house “mortgage experts” employed or recommended by the Estate Agents you are using if you are buying a property.

The reason they recommend them is that they earn referral income from them, not because they are the best one for you to use. Very often the mortgages you will be offered will be from a narrow panel of Lenders, again favoured by the Estate Agent or the “mortgage expert”.

You should also be aware that each mortgage application you make will be recorded on your credit file. Being turned down for a mortgage will adversely affect your credit score.

Therefore you should ideally only ever apply for one mortgage, and your mortgage broker should be confident that your application will be successful.

All mortgage brokers will receive a fee from the Lender, known as a procuration fee, for mortgages they arrange.

Procuration Fees vary by Lender but most are around 0.3% (i.e. £300 on a £100,000 mortgage). Most mortgage brokers charge their clients a fee as well.

Fee-free brokers who rely purely on the Lenders’ procuration fees for their livelihood often struggle to offer the quality of advice and service that charging brokers supply.

Mortgage brokers who charge a fee normally only charge when your mortgage funds are released, and you should be sceptical about using any mortgage broker who asks you to pay money up front. If you don’t secure a mortgage this is money down the drain.

Paying a fee, usually a few hundred pounds, to a Mortgage Broker on a success-only basis, to make sure you get the best mortgage for you, at the best rate available, could be money well spent.

If you want to remortgage without moving, the same applies. If you have a good credit record, equity in your property, and are stuck on a high variable rate with your current Lender, a remortgage could save you thousands of pounds over the mortgage term.

To compare which mortgages are currently available see our Mortgage Comparison Table

By Richard Watters

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