Tips For Choosing a Mortgage – Explained
Choosing a mortgage is one of the most important aspects of buying a house, so make sure you know all your options. The days are long gone when everyone paid pretty much the same mortgage interest rates, and you could only get a mortgage if you had dutifully saved with the same financial institution for some years.
These days, lenders vie with each other to attract business with a constant stream of new deals for both first-time buyers and borrowers looking to switch mortgages, resulting in hundreds of mortgage deals to choose from.
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- Standard Mortgage Types
- Special Mortgages
- Backing up an Interest-Only Mortgage
- The Options for Paying Interest
- Difficulties with Payments
- What To Do If You Have a Complaint
Standard Mortgage Types
The most important decision you have to make when choosing a mortgage is how you will repay it. There are two ways of doing this. Which of these you choose depends to a large extent on your attitude to risk.
The stability of your income and whether or not it may rise or fall over the foreseeable future is also a consideration when deciding on a mortgage.
The repayment mortgage – sometimes called the capital repayment mortgage – is the only risk-free way of making sure that you (rather than your lender) will own your home after the mortgage comes to an end.
With this type of repayment method, part of your monthly mortgage payment is used to pay interest and part is used to pay back the capital you have borrowed, although in the first few years most of your monthly payment is interest.
This means that you gradually pay off the loan and – providing you keep up your repayments – you are guaranteed to have repaid it in full by the end of your mortgage term. If you don’t want to take any chances with your mortgage, this is the repayment method to go for.
Riskier than a repayment mortgage, as there is no guarantee that you will pay off the loan and so own your home when the mortgage comes to an end. This is because, instead of paying back the loan little by little, the whole of your monthly mortgage payment is made up of interest.
None of the capital you have borrowed is paid back into the end of the mortgage term when you will be expected to pay off the entire loan in one go.
To ensure that you have a sufficiently large lump sum to be able to do this, you should make payments on some savings plan to back up your mortgage, as well as making the normal mortgage payments.
The risk you take is that the savings plan may not produce the lump sum you need to repay the mortgage, although if your investments do exceptionally well, you could end up with more than you need to clear your mortgage debt.
There are some variations on the standard mortgages on the market that exist now, offering the buyer greater flexibility and choice than ever before.
Although some of these products may seem quite different from the standard mortgage, you will still need to choose between a repayment and interest-only mortgage.
One of the greatest advances in mortgage products over the last few years is the introduction of the flexible mortgage (also known as the All-In-One, or current account (CAM) mortgage), where you manage your mortgage as a current account within certain limits.
This product was introduced in the 1990s from Australia (where they’re the standard mortgage) and now accounts for approximately 20% of all mortgages.
Your income and savings are held in the same account as your mortgage, which means that your effective mortgage balance is reduced. As you only pay interest on the lower amount, you could save a tremendous amount of money over time and help cut years off your mortgage. You earn the same interest rate on your savings as you pay on your mortgage and you can borrow additional funds at any time (up to the maximum agreed mortgage).
A flexible mortgage is ideal for people with savings, the self-employed (who need to put aside money to pay their taxes) and those who receive periodic lump-sum payments. You can usually vary your monthly payments, make overpayments, underpay (if you’ve made overpayments) and take payment holidays.
However, flexible mortgages come with higher interest rates than standard home loans, but the great advantage is that they potentially allow you to pay your mortgage off years earlier than you originally planned, and save thousands of pounds in the process.
Offset mortgages are a slight variation on the flexible mortgage, where your current account is held separately from your savings account. Your savings are then offset against the mortgage sum.
This means that if you have a mortgage of £200,000 and savings of £20,000, you will pay interest on £180,000 and will repay your mortgage quicker. No interest is paid on your savings, but you will save money on the mortgage interest.
Backing up an Interest-Only Mortgage
If you are attracted by the idea of combining the purchase of a property with the discipline of regular, long-term saving, you need to decide on the kind of savings plan you are going to use to back the mortgage.
Lenders make it very clear that it is your responsibility to make sure you are saving enough to build up the lump sum you will need to repay the loan.
If you fail to keep up the payments into the savings plan, or don’t pay into a savings plan at all, when the mortgage comes to an end the lender can make you sell your property if that is the only way you have of raising the cash needed to repay the full amount of the loan.
With an Endowment
In the past, the most popular form of savings plan to back an interest-only mortgage was an endowment policy. This is essentially a life-insurance policy linked to stock market investments.
The main disadvantages of this kind of savings plan that includes life insurance you may not need and you are tied to paying the monthly premiums for the full term of the mortgage. If you don’t, you risk getting back less than you paid in.
Even if you do manage to keep up the monthly premiums, there is no guarantee that your savings will grow sufficiently to produce the necessary lump sum. In recent years, thousands of people have been told that their policies are not on track to repay their mortgages because the underlying stock market investments have not performed as well as had been expected.
This endowment scandal has prompted most lenders to give up recommending interest-only mortgages backed by an endowment, in favour by ISA-backed mortgages.
With an ISA
The attraction of the mortgage backed by an individual savings account (ISA) is that an ISA is a more flexible and tax-efficient way of building up the lump sum and an endowment, and it doesn’t have to include life insurance.
The main disadvantage is that your investments are still tied into the stock market, so there is still no guarantee that you will build up the lump sum you need. You also need to be prepared to keep an eye on how will your investments are performing.
In addition, there is no guarantee that ISAs will continue after 2009, which means you might have to look for another savings plan at some stage.
With a Personal Pension
Using a personal pension to back an interest-only mortgage is tax-efficient, but also very risky. The idea is that you pay into a personal pension (which include stakeholder pensions) with the aim of building up a fund that will be used both to pay you a pension and pay off your mortgage.
However, only 25% of this money can be used to pay off the mortgage, so the fund built up in the pension plan is to be at least 4 times the size of your mortgage.
You should also be aware that if you have more than 25 years to go before retiring, you have to play mortgage interest for longer than your would with a mortgage linked to another sort of investment – you will be paying until you decide to take your pension.
Also, if you join an employer’s pension scheme, you may have to find another way of saving to pay off your mortgage, because you cannot normally pay into an employer’s pension and a personal pension at the same time.
The Options for Paying Interest
Once you have decided how you are going to repay the mortgage, you need to choose a type of interest bill that will best suit you.
The type of interest bill you choose can affect how long you are tied to the same lender and the kind of penalty fee you may have to pay if you move house or switch lenders in the future.
All lenders offer mortgages where the interest is charged at their standard variable rate (SVR), which goes up and down in line with interest rates in general.
In terms of monthly mortgage payments, it is unlikely to be the cheapest deal available, but there is usually no penalty to pay if you decide to switch your mortgage.
As the name suggests, with this type of deal you pay a lower than normal variable rate for a fixed period of time, which can be as little as six months or as much as five years. Some deals keep the same discount for that period, while others gradually reduced the discount each year.
A discounted rate is worth considering if you don’t mind that the your repayments will still rise and fall in line with interest rates in general, and you like the idea of paying less for your loan to begin with.
This is a variation on the standard variable theme. The differences is that the lender guarantees that the interest rate you pay will never be more than a fixed percentage above bank base-rate (the rate set by the Bank of England on which lenders base the rates they charge) and that changes in base rate will be passed on immediately.
This is an advantage when interest rates fall, but not so good when they rise.
With fixed-rate deals, the interest-rate you are charged is fixed for a set number of years – you are guaranteed to be able to pay that rate irrespective of changes in interest rates in general. At the end of the fixed-rate period, you revert to paying the lenders SVR.
Fixed rates are ideal if you are on a tight budget and want the security of knowing that your mortgage payments won’t go up and down for the first few years. However, you need to be aware that you are locked into a fixed-rate deal, so you won’t benefit if there is a fall in interest rates in general.
With a capped-rate deal, the rate you pay is semi-fixed in that it is guaranteed not to go above a certain level – the ‘cap’ – during the period that the capped rate applies. With some deals, there is also a lower limit – the ‘collar’ or ‘floor’ – which means that the interest-rate you’re charged cannot go below a certain level either.
A capped-rate can be more attractive than a fixed-rate mortgage if you have some flexibility in your budget (allowing you to cope with limited rises and falls in interest rates) and you want the certainty of knowing that there is a limit on how much interest rates can go up and down.
Difficulties with Payments
All lenders are required by law to print the following warning in all adverts and literature: “Your home is at risk if you don’t keep up repayments on a mortgage or loan secured on it”.
This warning means exactly what it says, and if you overextend yourself financially and take on a larger mortgage than you can afford to pay, you run the risk of losing your home.
If you run into any problems with your mortgage payments, you must discuss it with your lender straightaway. They may be able to help by reducing your payments, or by offering a payment holiday if your financial problems are only temporary.
If you are in trouble, take advice as soon as possible – you will only make the problem worse by ignoring it. The InterSites Debt resource centre offers a wealth of information, helpful tips and advice on managing debt.
One option would be to let out one of your rooms to help pay the mortgage, or even letting your entire home and renting a cheaper place for yourself. Whatever you do, avoid borrowing money from lenders who offer loans secured on your home. These loans are usually at exorbitant interest rates, and you are likely to make your situation worse.
If you stop paying your mortgage without notifying your lender, or if you fall too far behind with your payments (six months to a year), steps will eventually be taken to repossess your home. It will be sold at auction, and if the amount recovered is less than that owed to your lender, you can be sued for the balance.
What To Do If You Have a Complaint
The mortgage lending market is very complicated, and people can suffer at the hands of financial advisors and others who may offer unsound advice.
Anyone is selling mortgage linked investments, like endowments or pensions, must be qualified and registered, and must be able to demonstrate clearly that the policies they recommend are suitable.
Sales of investments are regulated by the Financial Services Authority, and all registered individuals and firms are inspected and can be fined or expelled from the industry if guilty of wrongly selling products.
However, advice on mortgages is currently only regulated on a voluntary basis by the industry, under a code of mortgage practice sponsored by the Council of Mortgage Lenders.
Although many of the major lenders are signed up to the code, there are still some who are not, so check first before taking advice.
If you feel that you need to make a complaint about the advice you have been given, you should follow these steps:
- Step One. Complain to the company that sold you the product, going through its internal complaints procedure.
- Step Two. If you are unhappy with the firm’s decision, approach the relevant complaints body:
- For complaints about lenders generally, or the mortgage advisors employed directly by them, contact the Financial Ombudsman Service.
- For mortgage lenders that are signed up to the mortgage code, but are not building societies or banks, contact the Chartered Institute of Arbitrators. You may also contact them if you have a complaint about a mortgage broker.
The most common complaint is to do with endowments. In the past, many people were advised to buy products that they later came to regret.
Complaints about endowments, pensions, and other investments are handled by the Financial Services Authority and dealt with by the Financial Ombudsman Service.
Remember, when choosing a mortgage – always ask questions, and never rush into anything. Always take advice if you are uncertain.