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Next to death and divorce, purchasing a home has been described as one of the most stressful experiences you can undergo. One of the factors contributing to this is the arranging of mortgage finance in advance of finding a property and owning it. Most first time home buyers will have to go through the complex world of mortgages, which includes a variety of lending offers, many of which are not as competitive as they may seem. It is therefore prudent to seek financial and mortgage advice at an early stage.

Mortgage regulation – Since October 2004, mortgages have been regulated by the FSA. (Prior to this, they were only regulated on a voluntary basis under the Mortgage Code). The FSA now insists that certain regulatory commitments are met. This means that advisers are obliged to provide you with information on their status – for example if they are independent or tied – and the level of advice they are qualified to offer.

They must also disclose on what basis they will charge you, for example a percentage of the loan or an hourly fee. It may be that they do not charge at all, receiving their entire fee from the lender to which they introduce your business.

Deposit – A deposit is the amount of money that you will pay upfront towards the price of the house. The balance will be made up from mortgage finance. The size of deposit, which is calculated as a percentage of the total house price purchase, usually affects the interest rate you pay (see below).

Some lenders do offer first time buyers 100 per cent mortgages, where no deposit is required but this will be dependent on your circumstances and may result in a higher interest rate. A more typical first-time buyer deposit would be between 5 and 10 per cent of the price of the property. For example, if you were required to provide a 10 per cent deposit and the purchase price was £150,000, you would need to put down a £15,000 deposit. Not having a deposit can make your mortgage a little more expensive.

Income multiples – Some mortgage lenders will base how much they will lend you on a multiple of your gross annual salary, usually at 3.5-4 x salary, sometimes more, sometimes less (could differentiate between typical single and joint lending limits). An increasing number of lenders now look specifically at affordability when considering how much they will lend you, taking into account your regular monthly outgoings. Also, in the face of rising prices, more lenders are now gearing themselves up to lend to groups of up to four or five people wanting to club together. They will typically lend multiples of the highest salary and take into account each of the other borrowers’ incomes.

Self certification – With many mortgage lenders, you will be required to prove how much you earn by supplying payslips, annual accounts etc. Some schemes allow you to ‘self certify’ your income. This type of arrangement may be appropriate for the self-employed who may have erratic income or complicated arrangements. Whatever scheme you choose, it is imperative that you are comfortable with the monthly commitment of the mortgage as the home you purchase will be at risk of repossession by the lender if you do not keep up to date with your repayments.

Repayment methods – The way in which you choose to repay your mortgage and the type of interest rate you select depend on personal circumstances and this is where a qualified adviser will be able to help. How the monthly repayment to the lender is organised will depend on the type of repayment method selected.

Repayment mortgage – With this method, you agree a term over which the mortgage should be repaid – typically 25 years. Then you make repayments to the lender on a monthly basis, consisting of both ‘capital’ (the sum you initially borrowed) and ‘interest’ (which accrues on it from day one). Assuming the agreed repayments are maintained, the loan is guaranteed to be repaid at the end of the term.

In the early years these payments will be primarily made up of interest; As the loan progresses, the interest is charged on a steadily decreasing amount of capital and the proportions of interest and capital shift; and as you approach the end of the loan, your last payments will comprise mainly capital.

Interest-only mortgage – With this method, only interest payments are made to the lender. The capital is saved month by month in a separate investment vehicle such as an endowment, pension or ISA. At the end of the loan term, provided there is sufficient funds to do so, the sum of this pot is used to pay off the interest in one go. In certain circumstances, such as lending on buy-to-let mortgages, the lender might be happy for no investment vehicle to be in place.

Some investment vehicles, such as endowments, have not performed well in recent years, leaving the borrower with a shortfall at the end of the mortgage term. It is therefore imperative that you seek independent professional advice if you are considering using an investment vehicle to repay your loan.

Mortgage types and interest rates – An interest rate is literally, in percentage terms, the rate that will apply to your loan. Different loan types will attract different rates of interest, which will be priced in different ways. A professional adviser should be able to recommend a package that suits your circumstances but here is a brief outline of the types of loans that you might be offered.

Variable-rate mortgage – The lender’s variable rate (often referred to as the ’standard variable rate’ or SVR) fluctuates and will generally follow the direction of the Bank of England’s monthly base-rate changes. However, sometimes this is not in equal proportion and it may not change at all.

Discount mortgage – Many lenders offer a discount from their SVR. For example, if you were offered a 1 per cent discount off the lender’s variable rate of 5 per cent, your rate would be 4 per cent. It is important to note that your rate will also have the potential to go up and down with the SVR. The period over which the discount is available will vary. It is standard practice among lenders to tie you into the mortgage for the same period as the discount applies and possibly beyond. The tie-in is the time during which you will have to pay a penalty if you redeem the loan. However, you can usually take the loan with you if you move house, as the vast majority of loans are now portable.

Fixed-rate mortgage – A fixed-rate mortgage allows you to set your rate at a certain level for a given period of time. So regardless of whether the lender’s rate changes up or down, your payments remain the same. Again, you will be tied in for as long as the fixed rate applies and possibly beyond.

Capped-rate mortgage – A variation on the theme of the fixed rate above, is a capped rate. The ‘cap’ really means that there is an upper limit on the interest rate you will pay. If the lender’s SVR rises above this limit, your rate will be unaffected, just as with the fixed rate. However, if the lender’s rate falls below the level of your cap, then your rate will fall. Again, you will be tied in for as long as the capped rate applies and possibly beyond.

Tracker-rate mortgage – Another type of interest rate is a tracker rate, which is occasionally linked to the lender’s variable rate but most commonly linked to the Bank of England base rate. The tracker follows the Bank of England base rate with a discount or a premium (or even sometimes at the same rate as Bank of England base rate) for a period of time. In this instance, any reduction will be passed on in full, which is not always the case if your rate is linked to the SVR. Some trackers, but not all, come with tie-ins.

Cashback mortgage – To attract your business, you may be offered a cash incentive or ‘cashback’, which is payable on completion of the loan. However, this type of mortgage may only be offered to you by linking it to the lender’s SVR.

Flexible mortgage – A flexible mortgage offers the facility to underpay or overpay or even take payment holidays. It also allows you to borrow lump sums back from your loan free of charge. There are no tie-ins with flexible loans, meaning you can redeem the mortgage at any time with no penalty. A true flexible mortgage will calculate your interest on a daily, not an annual, basis.

This means that the reduction in interest payments that occurs as a result of reducing capital kicks in on the next day rather than at the end of the year, as was traditionally the standard procedure. Fully flexible loans are usually priced at a variable rate of interest, although some fixed and discounted options are now emerging onto the market.

Offset mortgage – An offset mortgage takes a flexible mortgage one stage further and comes with all the flexible features described above but in addition offsets your savings – which must be transferred into an account with the lender – against the debt of your mortgage. For example, if you had £5,000 in savings and a mortgage of £100,000, you would only pay interest on the remaining balance of £95,000. The reduced interest you pay as a result of this arrangement means a shorter loan term. You will not receive interest payments on the credit balance of your savings but this means you will not pay tax on that interest either. Also, the interest you are forfeiting on your credit balance is nearly always lower than the rate you pay on debt balances. However, offset mortgages work most effectively if you have considerable savings – something that many first-time buyers might prefer to put towards a deposit. Interest rates on offsets can also be more expensive.

Current account mortgage – A current account mortgage is also completely flexible and works along the same lines as an offset mortgage. The main difference is that all balances are thrown into one big pot rather than being kept in separate accounts. You are also able to incorporate credit cards and personal loans into the pot. So if you had a total debt – including your mortgage – of £130,000 and savings of £5,000 your balance at the ATM machine would read £125,000 overdrawn. But all debt is charged at cheaper mortgage rates and all credit is offset against this debt, further reducing its cost. Current account mortgages are usually aimed at sophisticated, astute borrowers who know how to use them for the best results.

First Time Buyer Mortgages: Higher lending charge (HLC) – This charge was once known as a Mortgage Indemnity Premium (MIP) or a Mortgage Indemnity Guarantee (MIG). Some lenders levy the fee on loans above a certain Loan to Value (LTV) – usually either 90 or 95 per cent. This mitigates the ‘high risk’ that the borrower poses. A HLC basically amounts to an insurance policy for the lender, for which you, as the borrower, pay the premium. The lender wants this insurance to cover itself against the cost of the borrower defaulting on the loan, having to repossess the property and then sell it on.HLCs have received a very bad press in recent years and have consequently been on the decrease but you should still be aware of them. Some lenders will soften the blow by letting you add the HLC to the loan but this works out to be even more costly in the long term.

Redemption penalty – This is what you will pay to redeem your mortgage if you are still within the ‘tie-in’ period. Tie-ins vary in duration and usually apply to most loans that come with a cheap
initial rate. Redemption penalties are usually calculated as a percentage of the outstanding loan. A tiered redemption penalty is when the amount you pay to redeem reduces with each year of the tie-in.

Redeeming your mortgage is not to be confused with moving the loan to another property, as most schemes are portable and no penalty is levied. You should ask a qualified adviser to explain what, if any, penalties are payable if you wish to repay the loan. Redemption penalties can run into thousands of pounds so it is imperative you are aware of this at the outset.

Conclusion – In conclusion to our mortgage guide, and to reiterate what was mentioned at the beginning of this section, you must give proper consideration to how you finance your mortgage. Prepare yourself and make sure you are in a position to ask the right questions of a qualified adviser. He or she will be able to help you choose the right mortgage for your particular circumstances and requirements.

Useful websites

www.cml.org.uk – Council of Mortgage Lenders.

Helen Adams

www.FirstRungNow.com