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Beginner’s Guide: Mortgages

Published 15th May 2007

The choice has never been greater, but, for British homebuyers, finding the right mortgage has also never been more complicated...

The good news is that, with such a bewildering range of mortgages, from interest only to Islamic, there is almost certain to be the right mortgage out there for everyone.
Choosing a mortgage is about more than just finding a good rate. It’s a decision that should take into account your finances, your lifestyle, your attitude towards risk, and a bit of crystal ball gazing too.

Below is a run through the basics: different repayment methods, different loan types, some special cases, and some pitfalls to avoid.

1. Paying It Back: Repayment Or Interest Only?
At the most basic level, the first choice you have to make is whether or not to take out a repayment mortgage, where you pay off some of the money you have borrowed each month, plus the interest owing.

Or you could opt for an interest only mortgage, where you pay off no capital.

Your monthly outgoings will be reduced, but you do need to find some way of repaying the amount borrowed, such as an investment ISA, or a pension scheme.

It’s also possible to go the interest only route for the first few years of your mortgage and then switch back to a repayment loan.
This can be useful for first-time buyers who think their income will rise – but be prepared for the higher monthly costs when you switch to the repayment deal.

2. Standard Variable Rates & Other Deals
Next you will have to decide which type of mortgage product suits your circumstances the best.

Lenders have a basic rate, called their Standard Variable Rate, which tracks, but is usually higher than, the Bank of England’s Base Rate – for example, the Base Rate set by the Bank of England is currently 5.25 per cent but Halifax’s SVR is 7.25 per cent.

However, lenders also offer special mortgage deals for specific time periods – when the deal expires you go onto the SVR. At this point you can choose another deal or remortgage with another company – both of which make sense: you really don’t want to be on the expensive SVR.

Here are some classic deals offered by lenders:
3. Fixed Rates
The favourite for borrowers on a tight budget, a fixed-rate mortgage guarantees you the same monthly payment for the lifetime of the product.

The rate of interest may be slightly higher, but the ability to fix your payments for between one and ten years is usually worth it for peace of mind.

Although there is often talk of 25-year fixed-rate mortgages, a period of two to five years is more usual, with the interest rate increasing with the length of the product.
4. Discounted Rates
With a discounted mortgage you benefit from a low interest rate for a given period, usually a few per cent off the lender’s standard variable rate (SVR) for a year or two.

This may offer a cheap headline rate, but it is a more risky proposition. Any changes in your lender’s SVR will affect your monthly payments so you need to know you can cope with a rise.

5. Stepped Rates
These are similar to discounted in that you start off on a low initial rate, which then ‘steps up’ to a higher rate after a period of time, but both rates are fixed in advance.

The general rule is the lower the initial rate, the higher the stepped up rate. So, you may find a bargain rate of 1.99 per cent for a couple of years, which leaps up to 6.49 per cent for the remaining four years of the deal.

This could add £375 per month to a £100,000 interest only mortgage. And if you try to get out of the deal you will be hit with Early Repayment Charges.

6 Tracker MortgagesA tracker is much like a discounted mortgage, but it shadows the Bank of England base rate for an agreed period of time, e.g. 0.02 per cent above base rate for two years.

This can be the cheapest mortgage on the market, but it carries the risk of higher monthly outgoings if the bank base rate rises.

7. Capped Mortgages
With advantages of both the fixed and variable rate mortgages, a capped mortgage insures you against interest rises over an agreed level, but if interest rates fall significantly your monthly payments can come down too.
Of course, for such a good option, you will often pay a higher interest rate.

8. Flexible Mortgages
Designed to suit the needs of borrowers, rather than lenders, a flexible mortgage allows you to make overpayments, and take payment holidays as your finances fluctuate.

However, flexibility comes at a price, and you may find that the higher rate is not worth it when many more conventional mortgages are now offering similar features.

9. Cash-back Mortgages
The idea of a cash-back mortgage is that on completion the lender gives you a lump sum, either a fixed amount, or a percentage of your loan, to spend on whatever you want.

But, for your cash handout you will have to put up with a higher interest rate, and you will be tied into the deal for a set period, so make sure you wouldn’t be better off getting your lump sum elsewhere.

10. Offset Mortgages
Strictly for those with substantial savings in the bank, an offset mortgage uses your funds to offset the mortgage. So, if you have a £100,000 mortgage and £25,000 in savings, you will only pay interest on the £75,000 difference.
It’s a good way to make use of your savings, it’s tax efficient if you pay higher rate tax, and it means you can pay off your mortgage quicker, but you may pay a higher rate.

Working out whether or not an of
Offset mortgage will save you money can be complicated, and it is probably worth taking advice from a mortgage adviser.

11. 100 Per Cent Mortgages
While most mortgage deals require a deposit of at least five per cent, having no savings doesn’t necessarily mean you can’t afford to buy. One hundred per cent mortgages allow many first-time buyers to make the first rung of the ladder.
However, you will be charged for the bank’s risk, both within the interest rate and a one off Higher Lending Charge, which the lender will use to take out insurance cover against you defaulting.

Plus, don’t forget that if house prices take a nose dive, 100 per cent borrowers are at an increased risk of negative equity.

12. Self-Certification Deals
If you are self employed and don’t fulfil the lenders’ usual requirements you may be able to get a self-certification mortgage.

Obviously, if you aren’t in secure employment you pose a bigger risk to lenders, so you can expect this to be reflected in the interest rate, although the bigger the deposit you can put down, the better rates you can find.
Self-certification mortgages are available as all the usual types of product - fixed rates, capped rates, discount rates, tracker rates and buy-to-let.

13. Buy-to-let
If you want to invest in a rental property you will need a buy-to-let mortgage.

You will typically have to put down 20-25 per cent of the property’s value as a deposit. And the decision on whether to lend the money is usually based on either a combination of your income and the rental potential, or solely on the rental potential of the property.

Ten Things To Watch For
1. KFI Information: The FSA now regulates mortgage lending and has stipulated that lenders and brokers must provide prospective borrowers with a KFI (Key Facts Illustration).

This should tell you:
• The overall cost
• What you’ll pay each month
• What fees you need to pay
• If there are any special features of the mortgage
• What happens if you don’t want it any more

2. How much can you borrow? Traditionally banks and building societies lent 3-3.5 times a single salary, or 2.5-2.75 times joint earnings. But if this doesn’t work for you look for a lender that will make a decision based on your ability to maintain the debt.

3. Arrangement fees: Seeing beyond the headline rate to what your home will actually cost you in the long term is not always straightforward.

A rate might look attractive, but read the small print as increasingly lenders subsidise low rates with higher arrangement fees – arrangement fees have been rising fast of late as lenders seek to recoup money on low-rate deals.

4. Early repayment charges: Lenders can charge you extra if you repay your loan earlier than the term of the mortgage so it makes sense to take out a mortgage where there are no ERCs or only ERCs within the initial, favourable term of the loan.

Watch out for bargain rates that have extended tie-ins making you liable for a penalty after the initial term of the mortgage. These are called 'overhanging' ERCs and they lock a borrower in whilst still paying a lender's Standard Variable Rate.

5. Mortgage overpayments: If you can afford to pay a bit more each month, go for a mortgage that allows you to overpay – over the long term this can save you serious amounts of cash.

6. Exit fees: These fees are charged when you want to leave your current deal. They come under a variety of names including exit fees, administration charges, sealing fees or deeds-release fees.
They tend to be around £195-£295 but this figure is rising as lenders look to recoup lost revenue from competitive rate pricing. Check how much, and whether they can be avoided.

7. Higher lending charges: HLCs apply to borrowers who do not have a large deposit. They are charged by lenders, usually on loans over 90 per cent loan-to-value, who view these borrowers as a greater risk because they haven't shored up their borrowings with a down payment.
But there are 100 per cent mortgages around these days that don’t carry excessive penalties.

8. MIG: Relating to the last point, some lenders will demand Mortgage Indemnity Insurance if you borrow more than 80-95 per cent of the property’s value.

Note: In most cases, the mortgage indemnity will cover your lender only for part of its loss if you default, and they can come after you for the rest. So tread carefully.
One way around this is to borrow just below the threshold. So if it starts at 95 per cent, take out a mortgage for 94.99 per cent.

9. Tie-ins: Some lenders will charge you a fee when you take your buildings insurance out with a company other than your mortgage provider, or when you change your mortgage - even when remaining with the same provider.

10. Incentives: Lenders sometimes offer incentives such as free valuations or paying your legal fees, but check that the cost of the mortgage is not more expensive and that there are no tie-ins or other fees (sometimes you have to pay back the value of these incentives if you pay off the loan early).


Source: ' Findaproperty '

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