TheRateTart Mortgage Guide
Contents
- Introduction
- How Mortgage Lenders Make Money
- How to use this guide
- What mortgage repayment options are there?
- How can I save money on monthly mortgage repayments?
- What fees and charges apply to mortgages and re-mortgages?
- Niche Lending
- Tips from TheRateTart
A mortgage is a loan made for the specific purpose of purchasing property. The word is derived from a French phrase meaning 'debt until death'. Though most can expect to be mortgage free somewhat earlier than this, a mortgage is still likely to be the biggest and longest lasting debt we incur. On the other hand, long term house price growth has meant that,for many people, property has also been a highly profitable investment. TheRateTart guide to mortgages will help you to make sense of the maze of options, so you can compare with confidence.
How Mortgage Lenders Make Money
Mortgage Lenders make money primarily from interest and fees. So the trick is to understand how they try to get the most out of you. Some common techniques are:
- Only recalculating interest once a year so that you pay interest all year on what you owed at the start of the year
- Jacking up interest rates straight away when the Bank of England base rate goes up, but taking their time when the interest rates go down.
- Counting on customer inertia, i.e. trying to keep as many customers as possible paying Standard Variable Rate (or other non discounted rates)
- And increasingly making it difficult / un-profitable to switch by increasing exit fees etc
- Tempting you with cash-back, and clawing it back if you leave the deal early
- Keeping the best deals for new customers
- Increasing interest rates for self employed mortgages
- Convincing you to buy their own Payment Protection Insurance (PPI) , buildings insurance and other 'cross-sells' rather than shop around for a better deal.
Mortgage lenders are very aware that their products are compared in best buy tables. In fact it is becoming increasingly common for them to design products specifically to get the top spots in comparison tables. One way of doing this is to have a great headline interest rate, and make up any lost profit margin by charging high fees that are not included in the headline interest rate. If you want to know how much mortgage deals will cost you, make sure that you compare the Total Amount Repayable for each offer.
How to use this guide
The first thing to consider is what repayment option you want. The different options, together with their features and benefits are described below. Once you've done this you will need to think about how to minimise you monthly repayments. This is described in the next section. Then take a look at the section on Fees and Charges that could be applied to a mortgage. This is important as many lenders hike these up to offset low interest rates which gain them a prominent position in the best buy tables. If you are a landlord, self employed or a first time buyer, you may need to review the Niche Lending section for details on the types of mortgages available to these customers. Finally, don't forget to check out the 'Tips from TheRateTart' to learn about the traps that might be hidden in the terms and conditions of your mortgage offer.
What mortgage repayment options are there?
There are two approaches to making mortgage repayments;
Repayment Mortgages use your monthly payments to repay both the capital (i.e. the original amount borrowed) and the interest accrued on the loan. The amount paid against each is not equal and the ratio varies over time. Early on payments against interest are dominant. This means that if you move house frequently you could spend a lot of time paying off interest rather than capital. However the mortgage is guaranteed to be repaid in full at the end of the term. In effect, you pay a premium for the peace of mind of knowing that your mortgage will be paid off at the end of the term.
Interest Only Mortgages use your monthly payment to pay off only the interest component of the mortgage To pay off the capital the borrower must make regular contributions to an investment vehicle such as an Endowment policy, ISA or pension. This involves an element of risk, as it cannot be guaranteed that the investment will grow to the level required to pay off the loan. The upside is if you manage the investment well enough, you could either pay off the capital early or generate a surplus to keep for yourself.
If taking on an interest only mortgage consider consulting an Independent Financial Adviser (IFA) to help choose the right investment product for you. Check out www.unbiased.co.uk for your nearest IFA. When choosing an IFA make sure you understand how they are re-numerated. Typically this will be either an upfront fee payable by the client (i.e. you), commission on products sold, or a mixture of both. Whatever model is used, don't just accept the recommendation given. Make the IFA earn their money by explaining to your full satisfaction why the product recommended is the best one for you. The main types of investment vehicle to research or get advice on are endowment policies, ISAs or a pension fund.
Make sure you review the performance of your investment regularly to make sure it is on track. Remember, it is your responsibility to make sure the loan can be repaid, not that of the lender.
You can use either repayment method with a mortgage linked to your current or savings account. These are known as offset mortgages and are described later on in this guide.
How can I save money on monthly mortgage repayments?
The monthly mortgage repayment is the biggest expense in most household budgets. By avoiding the standard variable rate, first time buyers and re-mortgage customers can save money and reduce the impact of interest rate rises. The range of packages may appear confusing. But in a glass-half-full view of the world this means there is more chance of finding a money-saving mortgage deal you'll like.
Standard Variable Rate or SVR is the default mortgage interest rate a mortgage lender charges borrowers. For default, also read 'highest'. If you are paying SVR then you are almost certainly paying more than you need to. SVR usually moves up and down with the Bank of England base rate. However there is no guarantee that lenders will pass on the benefit quickly (or indeed at all) from a fall in base rate Even if they do, it is unlikely to be passed on as quickly as a rate rise. A call to your current lender telling them you are thinking about switching could result in them offering you a better deal. But to make sure you are saving as much money as possible, compare any offer with deals available for re-mortgage customers from other lenders.
Fixed Rate mortgages provide customers with certainty by guaranteeing that the stated interest rate will not change for a specified period. If interest rates go up, you will not have to worry about finding extra money for the monthly repayment. Equally, if interest rates go down, this reduction will not be passed on to you by the lender.
Capped Rate mortgages contain an interest rate that moves up and down with the base rate, but is guaranteed not to rise above a certain level. If interest rates go down you will save money. Though the interest rate is capped, don't just assume you will be able to afford any increases.Check your budget can support monthly repayments at the highest possible interest rate.
Discounted Rate mortgages offer a discount off the lender's SVR for a fixed period of time. These can offer the lowest up front monthly payments. But because these deals track the ups and downs of the base rate, you need to be confident that your budget can accomodate increased monthly payments should interest rates go up. And no, we can't tell you how much of a rate rise to budget for. Or this week's lottery numbers either.
Tracker Rate mortgages track the Bank of England Base Rate. A Tracker Rate is guaranteed to be a fixed percentage over the base rate for a fixed period of time.This also means that reductions in the base rate are guaranteed to be passed onto the borrower. Although unlikely to offer the cheapest monthly repayments, they are cheaper and more predictable than Standard Variable Rate. Expect Tracker Rate deals to be offered for longer periods than Fixed, Capped or Discounted Rates (sometimes for the life of the mortgage). If you do not want to switch mortgages every few years, a Tracker can offer a good alternative to Standard Variable Rate.
Flexible Mortgages offer the facility to make over-payments, under-payments or take payment holidays. Unlike traditional mortgages, these mortgages calculate interest on a daily or monthly basis (see 'How Mortgage Lenders Make Money'). This maximises the impact of any overpayment or underpayment in favour of the borrower or lender respectively. In theory making over-payments could save you money by knocking years off your mortgage. This could be useful if you expect your salary to be topped up by period bonus payments or overtime. However if your income stays broadly the same you may be better off with either an Offset Mortgage or a fixed, capped or discount rate mortgage on a shorter re-payment term.
Offset mortgages combine the features of a Flexible Mortgage with a linked current or savings account held with the lender. The funds in the current or savings account are used to reduce the mortgage balance on which interest is payable. For example if the customer's mortgage account has a balance of £50,000 and their current or savings account has a balance of £5000, mortgage interest is charged on £45,000. Be aware that no interest is paid on the credit of a current or savings account offsetting a mortgage account, and consequently no tax liability is generated. Current account mortgages are a variation on this type mortgage where the lending is only offset against a current account rather than combining this with a savings account.
Tip from TheRateTart. Are you on a deal with a variable interest rate (capped rate, discount rate or tracker rate)? Consider opening a savings account to deposit the difference between the current payment and the maximum affordable payment each month. You can use this to cushion the impact of any interest rate rises, or of any period charged at Standard Variable Rate after the end of your introductory deal. And if you are not tied into SVR after the end of the capped rate period you can use it to help pay your re-mortgage fees. Or you could just go shopping. To make sure you do not forget register with TheRateTart and use our email alert system.
What fees and charges apply to mortgages and re-mortgages?
Lender Fees
Valuation Fees cover the cost to conduct a valuation of the property on behalf of the lender not the buyer. It is important to note that a lender's valuation is not the equivalent of a 'Housebuyers report' or 'Full Structural Survey', both of which are produced for the buyer wanting to identify any serious problems with the property.
Booking Fees are payable at point of application and are usually non-refundable. Typically levied on competitive deals where funds are limited, they are used to discourage customers from making an application whilst still shopping around for a better deal.
Arrangement Fees are payable at completion and can often be added to the mortgage loan. This can reduce the amount you have to pay up front. But don't rush to thank your lender too quickly.The interest on this additional lending over the life of the loan means you will end up paying far more than if you had paid the fee up front. To get the best of both worlds, you could consider using credit card with a 0% on purchases rate to pay your mortgage fees. Click here to read our guide to credit cards.
Understanding the up front fees on a mortgage is increasingly important when deciding which deal to go for. Some lenders are increasing up front fees to pay for reductions in interest rates. This can make the mortgage look like a better deal than others on the market. In reality, once fees are taken into account the total cost of the loan over both the introductory period and overall term may not be so competitive.
Other Costs and Charges
Solicitors Fees cover the cost of the various legal investigations which form part of the conveyancing process. This includes registering the property with the Land Registry, conducting searches to identify and factors which may affect the property, handling title fees and so on. Some lenders will pay legal fees, but this requires you to use a solicitor from a list approved by the lender. Approved solicitors are required by law to act in your best interests. However, as they are getting paid a set fee by the mortgage lender you may find them unwilling to go the extra mile (e.g. if you are in a hurry).
Stamp Duty is a tax payable when you purchase a property and therefore does not apply when re-mortgaging. At the time of writing, the tax is levied at 1% on properties valued between £125,001 to £250,000, 3% for £250,001 to £500,000, and 4% for £500,001 and over.
Buildings Insurance covers the cost to rebuild the entire property should it be destroyed or severely damaged. All lenders will require evidence that the property is adequately insured before releasing funds. Although increasingly rare, some lenders require you to take out their own buildings insurance to qualify for a mortgage deal. A lender's own insurance is rarely the cheapest available, so consider the impact of this on the total repayment costs before signing up.
Payment Protection Insurance (PPI) is an add on product that guarantees to pay back your mortgage if you are no longer able to do so. But only under specific circumstances. Lenders are keen to sell PPI as the profit margins can be high, whilst claims are relatively low. The Financial Service Authority and Office of Fair Trading have all recently been critical of PPI. The main concerns are the high costs to customers and concerns that many customers have been mis-sold policies. If you do decide to take out PPI, get the best deal by;
- Shopping around. You are not obliged to take out PPI from your lender. Often you will be able to get a much better deal separately.
- Make sure the Terms and Conditions are right for your circumstances. For example if you are self employed the policy may not pay out if a downturn in business means you are no longer able to meet your repayments.
Niche Lending
Buy to Let mortgages are specialist deals aimed at the growing landlord market. These mortgages typically have a maximum loan to value of 70-80% and also require the borrower to prove that the income rental will cover approximately 130% of the mortgage payments. Continued house price rises may make Buy To Let seem like easy money. But don't kid yourself that this is a fool-proof option. Both house prices and rental income can go down as well as up. Could you afford to keep on both your main residence and a Buy to Let if times got tough? Think carefully about whether you are prepared to deal with the demands of tenants. You can get an agency to manage this for you, but this will eat into your profits.
Self-Certification Mortgages do not require income verification so are suitable for those who have difficulty producing traditional proof of income. For example, the self employed, or those with several sources of income. Historically lenders have viewed self-certification as high risk and been reluctant to lend under these circumstances. But as the size of this segment has increased and the main-stream mortgage market has become more competitive, some lenders view self certification as a profitable source of growth. Whilst interest rates remain higher than for other types of mortgage, increased competition in this area should start to drive prices down in coming years.
High Loan to Value Mortgages offer to lend more than the 90-95% of the property value which is the typical upper limit of mainstream mortgages. High Loan to Value mortgages are targetted at customers who do not have a deposit saved or who want extra funds to improve their new property. There has been controversy around these mortgages as they can lead to borrowing greater than the value of the house. If house prices fall, this could leave customers with debts greater than the value of their house: "negative equity". In some cases the amount borrowed over 100% is secured against the house, whilst in other cases it is in the form of an unsecured loan However continued house price rises have meant that some borrowers have seen this as an attractive alternative to an extended period of renting whilst they save for a deposit. The housing market can go down as well as up, so borrowers should be wary of assuming that their property value will increase to cover the cost of extra borrowing in a short period of time.
Tips from TheRateTart
This is not an exhaustive list, but here are some tips from TheRateTart to bear in mind when applying for a mortgage.
Early Repayment Penalties are charges that are levied should a mortgage be repaid within a specified time period. The penalty is usually stated as 'x' months of interest rather than a set amount. These penalties are often used by lenders to tie customers into their mortgage for a period of time after a special introductory offer has ended. If a mortgage has no Early Redemption Penalties attached, it is unlikely to be a particularly competitive deal. Technically this gives the borrower more freedom to switch when a better deal comes along. In practice, the fees associated with re-mortgaging mean switching more frequently than every 2-4 years is unlikely to be profitable anyway. Coincidentally, the duration of many special deals plus redemption penalty window is about 2.5 to 4 years...
Exit Fees are charges levied by the lender when closing a mortgage account. These are a distinct from Early Repayment Penalties (ERPs) and apply even if re-mortgaging outside the ERP window. Exit fees are meant to cover the administrative costs of closing the mortgage account (e.g. Land Registry changes). However many consumers and media commentators have viewed recent steep increases in exit fees as being effectively an extension of ERPs. The Financial Services Authority is currently investigating these increases to determine whether they represent a breach of the Unfair Terms in Consumer Contracts Regulations 1999. Their report is expected in November 2006 and will be available at www.fsa.gov.uk.
Cashback is a cash incentive that can be provided at different times during a mortgage (but usually at completion) to encourage customers to select that deal. It can be provided in the form of a cheque, or knocked off of the overall mortgage cost. The "Clawback" of the cashback takes place when the customer redeems the mortgage early to move to a better rate. This is either via an overt requirement to repay or alernatively is incorporated into an inflated ERC rate so that you do not realise that this is happening.
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