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There are many different types of mortgages and there will be one out there that best suits your requirements.
Seek financial advice from a fully qualified mortgage professional – who has access to all of the mortgage products on the market made available to mortgage brokers (they are referred to as ‘whole of market advisors/brokers’).
A good mortgage advisor will only advise and recommend a mortgage after they have fully assessed all your circumstances and needs. There are two main advantages of using a mortgage advisor – they have a thorough understanding of the varying lending criteria of different mortgage companies and knowing which lenders will lend in a given situation is of paramount importance. The second element is up to knowledge of all the different rates and products out there as lenders can frequently change what they are offering and it can be a full-time job just to keep up to date.
Mortgages unlike car insurance do not lend themselves to being compared. The number of different factors affecting the overall cost means that working out which product is really the most cost effective is a complex and time consuming process that requires knowledge and experience that a comparison website does not provide.
It is very common for the lowest rate product to actually be much more expensive in terms of overall cost than other products with a higher headline rate and the complex nature of how fees are added to loans makes them difficult to compare like for like.
In the meantime here is some basic information about mortgages in the UK;
There are essentially two different types of mortgage
Your monthly repayments consist of repaying the capital amount borrowed together with accrued interest. On your mortgage statement, normally received annually, you will see that the outstanding balance decreases throughout the term.
With this type of mortgage, each mortgage payment is only used to pay off interest. At the same time, the borrower takes out an alternative ‘repayment vehicle’ (method of paying off the mortgage) such as an ISA, pension plan or endowment policy.
When you have chosen the right mortgage for you, whether it be a repayment or an interest only mortgage, you will need to consider the 5 main mortgage rate options available.
With a fixed rate mortgage the amount you repay the lender each month can be at a fixed interest rate for a specified period of time, regardless of changes to interest rate in the market place. It is common for lenders to offer rates fixed for a period of 2 to 5 years, but shorter and longer periods can be found in the market. At the end of the fixed rate (or ‘benefit’) period the rate will normally convert to the lenders Standard Variable Rate (SVR).
It is normal for lenders to charge up-front fees in the form of booking and/or arrangement fees. In addition lenders frequently apply an Early Repayment Charge (ERC) for fixed rate mortgages. This acts as a ‘lock-in’ making an often heavy charge for borrowers paying off their mortgage early. Watch out, as the ERC can sometimes last longer than the fixed rate period e.g. a 3 year fixed rate with a 5 year ERC.
A capped rate mortgage is very similar to a fixed rate mortgage except that if the variable rate drops below the capped rate, the borrower will make payments based on the lower variable rate. However, should rates increase the payments will be ‘capped’ and will not rise over the capped rate. So as a rough ‘rule of thumb’ a capped rate is better to have than a fixed rate if all other factors are equal. Again, as with fixed rates, up-front charges and ‘lock-ins’ are common.
The Lender offers a discount on the Standard Variable Rate (SVR) for a specific period of time. For example, the variable rate may be 5% with a discount of 1.5%. The initial pay rate would therefore be 3.5%. If the variable rate rose to say, 6%, then the rate payable would rise to 4.5%. As the discount is linked to the standard variable rate, the borrower’s payments will increase if rates rise - so there is no certainty in budgeting. However, should rates decrease, the borrower will benefit from lower payments.
It is still possible to have up-front charges for discounted products and an Early Repayment Charge is common.
With discount mortgages borrowers need to watch out for ‘payment shock’. Some short term discount products offer a ‘deep discount’ e.g. 4% off for 1 year. In such circumstances the borrower will be facing a significant increase in their monthly mortgage payment at the end of the discount benefit period.
Borrowers paying the Standard Variable Rate will have their payments increase or decrease as the lender adjusts the rate in accordance with market conditions.
This is a variable rate that is linked to the movement of a prevailing rate such as The Bank of England Base Rate or London Interbank Offered Rate (LIBOR). The pay rate will be a set percentage amount above the relevant base rate for a specified period of time. For example if the tracker mortgage is set at 2.5% above The Bank of England Base Rate for 5 years and the base rate is currently 0.50%, the pay rate will work out at 3.50%.
As their name suggests the rates of tracker mortgages change to follow ‘track’ changes in the base rate to which they are linked. So if the base rate increases by 1%, the pay rate will increase accordingly. Also if the base rate is reduced, borrowers will benefit from a lower pay rate.
A Flexible or ‘lifestyle’ mortgage is designed to let you make extra repayments when you have extra money, and to reduce or even skip payments when necessary. Borrowers will normally have to build up a reserve through overpayments before being allowed to underpay or skip payments. The main benefit of flexible mortgages is that many schemes are offered on a Daily or Monthly Interest Calculation basis (sometimes referred to as ‘daily rest’ or ‘monthly rest’). Until the arrival of flexible mortgages most, if not all, UK lenders were charging interest on an annual basis. This meant that borrowers making over-payments were not getting the benefit straight away because it could be a year before the capital was reduced by the over-payment. Whereas, on a mortgage where the interest is being calculated on a daily basis, any over-payment reduces the mortgage balance immediately, hence the borrower will be charged less interest from the next day. Without going into detail to explain this feature the up-shot is that over-paying the mortgage on a monthly or regular basis, even by a relatively small amount, will reduce your mortgage term by years (hence saving payments).
Many flexible mortgages come without any Early Repayment Charge so the borrower is not ‘locked-in’ to any particular lender. In addition the interest rate charged is often lower than the usual Standard Variable Rates charged by the other more ‘traditional’ mortgage lenders.
The flexible mortgage concept was imported from Australia so occasionally you may hear them referred to as ‘Aussie style mortgages’.
A flexible mortgage linked to a current and/or savings account held with the lender. These are sometimes referred to as Current Account Mortgages (CAM). These mortgages take the benefits of the flexible mortgage and use the funds held in the current and/or savings account to offset the interest e.g. on a particular day a borrower has a mortgage balance of £50,000 and has £2,000 held in their current and/or savings account. The customer is charged mortgage interest on £48,000 i.e. the mortgage balance minus the positive balance held in the current and/or savings account.
Borrowers should note that when using the money held in their current and/or savings account to offset their mortgage, they will not receive interest on the credit balance held in the accounts.
Some of the lenders in this sector are also incorporating credit cards and personal loans into the mix.
For a borrower wanting one home for their finances this is an attractive option.
The Lender, as an incentive, will offer a lump sum of cash once the mortgage has been taken out. The amount will vary from lender to lender and on the size of the mortgage. The amounts can range from a flat fee e.g. £200, to a percentage of the loan e.g. 3% of the loan.
Normally the cashback is offered as a package of benefits e.g. linked with a discount, but pure cashback products are not uncommon. Mortgages offering a 5 or even 6% cashback can be found which would mean a borrower taking a £70,000 mortgage would receive £4,200 on completion (at 6%).
As you would expect lenders apply an Early Repayment Charge with cashback mortgages. Typically a borrower will be locked-in for 5 to 7 years where a substantial cashback has been paid.
Free Legals or a Contribution Towards Conveyancing Costs
More common on products aimed at the remortgage market but a frequent product ‘enhancement’. To take advantage of the offer the mortgage applicant will normally need to use a firm of Solicitor's or licensed conveyancers nominated by the lender.
Free Valuation or Refund of Valuation
A free valuation requires no up-front payment from the mortgage applicant whereas a refund of valuation will only be made when and if the mortgage application completes. Hence an applicant paying for a valuation and then not proceeding due to, say, a poor valuation will not have their valuation fee refunded
Given that the mortgage market is very competitive many mortgages are sold as ‘loss leaders’ i.e. the mortgage has to be held for a number of years before the lender breaks into profit. As a consequence lenders frequently ‘lock-in’ borrowers by applying Early Repayment Charges for those paying off the mortgage early. Charges can be significant e.g. 6 months interest or repayment of the amount of benefit received, be it cashback or reduced interest. The period for which an Early Repayment Charge applies can vary. Sometimes it will match the period of the discount/fix but often it can go beyond the benefit period e.g. a 5 year discount with a 7 year ERC. This is referred to as an overhang.
On this subject see ‘No Early Repayment Charge’ and ‘No Overhang’ below.
Selecting ‘No Early Repayment Charge’ means that the mortgage schemes on screen will allow you to repay the loan in full, at any time, without applying an early repayment charge.
Most mortgage schemes, in return for offering you a lower initial rate, will require you to stay with that scheme at least for the period of the Discount, Fix or Cap, and often longer. If you wish to repay the loan in this time, or you remortgage with another lender, you will have to pay an Early Repayment Charge which can cost £thousands (6 months interest is common) depending on the lender and scheme.
With ‘No Early Repayment Charge’ mortgages you will not have to pay this early repayment fee (although there may still be other costs such as sealing fees and legal fees.) As a consequence of not being ‘locked-in’, the rate offered on these schemes will usually not be as competitive as for mortgages with early repayment penalties, making them most suitable for those who are likely to keep track of current rates and wish to remortgage quickly if they find a better rate, or those who may have to repay their loan in the first few years.
Selecting the ‘No overhang’ option means that the mortgage schemes on screen will allow you to repay the loan without penalty once the benefit period has ended i.e. the mortgage does have an Early Repayment Charge but it does not last beyond the fixed, capped or discount period. This means that a mortgage with, for example, a discount to 31st January 2006 will have an early repayment charge to either the same date or a date prior to this.
The Early Repayment Charge can represent a significant sum although the amount will differ between lenders and between products.
With ‘No overhang’ mortgages you will only have to pay this early repayment fee if you redeem the loan or remortgage whilst you are still subject to the scheme’s special rate. Once you have reverted to paying the lender’s Standard Variable Rate (SVR) you will be able to redeem the loan without penalty (although there may still be other costs such as sealing fees and legal fees.) As a consequence of not locking-in the borrower to the lender’s SVR, the rate offered on these schemes will usually not be as competitive as for rates with early repayment overhangs, making them most suitable for those who wish to benefit from a lower initial rate without needing a very low initial rate, and who are likely to want to remortgage to another Discount, Fix or Cap once they are no longer benefiting from the initial rate.
Where the amount borrowed exceeds a specific percentage of the property’s value (set by the lender) you may be charged a Higher Lending Charge by the lender. The lender uses this fee to take out insurance to protect itself against any losses incurred if the property needs to be taken into possession because of serious arrears. It is common practice for lenders to pass this charge on to the borrower. Depending on the amount of loan and the Loan to value (LTV) the Higher Lending Charge can be a significant cost e.g. a £47,500 mortgage on a purchase price / valuation of £50,000 would result in a £750 charge on a typical HLC of 7.5% on a normal lending limit of 75% loan to value. Most lenders have a different name for this charge i.e. it may not appear on the mortgage Offer as Mortgage Indemnity Charge or High Percentage Lending Fee.
There are some important facts to understand about the Higher Lending Charge. It acts as a form of insurance for the lender not the borrower. This means that the lender can claim part or all of its ‘losses’ incurred repossessing the property from the insurance company providing the cover. Note that even after repossession the former borrower will remain liable for any sums owing (shortfall between selling price and mortgage outstanding plus arrears, lender's legal costs and any other charges applied to the mortgage) and can be pursued by the insurance company for payment at a subsequent date.
The amount charged to conduct a valuation of the property on behalf of the lender. It is important to note that the valuation is carried out on behalf of the lender - not the mortgage applicants! Frequently lenders include an administration fee as part of the valuation fee collected to cover the costs of arranging the valuation. The valuation does not represent a detailed inspection. For peace of mind it may be appropriate to obtain a ‘Housebuyers Report’ or a ‘Full Structural Survey’. These are more detailed than a lender valuation and they are produced on behalf of the applicant. They are more expensive than the lender's valuation.
Both are up-front fees charges levied at the outset of the mortgage.
A booking fee will normally be required with the application form. A booking fee is paid to reserve funds on a mortgage product that has limited funds available e.g. a first-come, first-served fixed rate. Booking fees are often non-refundable, so if the mortgage applicant cancels the mortgage application before completion the fee will not be reimbursed.
An arrangement fee is typically charged on completion of the mortgage. Arrangement fees are common on fixed and capped rate mortgages. Frequently they can be added to the mortgage hence the fee does not become an ‘out of pocket’ expense.
It is necessary to have a solicitor or licensed conveyancer to act on behalf of the mortgage applicant and the lender in the house purchase or remortgage transaction. The costs will be greater for house purchase than for remortgage. It is the role of the solicitor or licensed conveyancer to note ownership of the property on the title deeds; note the lender's interest in the property; register with the Land Registry and conduct searches to identify if there may be factors which could affect the property e.g. coal mining search to check for subsidence; check to see if there are some planned major road developments going through the back garden etc.
There are a whole series of other fees that some lenders apply in certain circumstances e.g. arrears, late payment, removing the lenders name from the Title Deeds at the end of the mortgage. Under the terms of The Mortgage Code of Practice the lender will, before a mortgage applicant takes a mortgage, provide a tariff covering the repayment of the mortgage, including charges and additional interest costs payable in the event of arrears and will advise of any other charges for services before or when the service is provided.
Glynn Webb Dip (PFS), Cert CII (MP & ER)
Tel: 01604 877770