This Fact Sheet deals with the types of mortgage products available, the methods of repayment (Capital & Interest and Interest Only), general information which is important to all prospective borrowers, then information on Mortgage Payment Protection insurance. You must take care over your choice and this Fact Sheet should assist you. First let’s look at the types of mortgage schemes that are generally available, then move on to the different methods of mortgage repayment, and so on.
There are numerous mortgage products available, such as Fixed Rate mortgages, Discounted Rate schemes, Flexible mortgages, Offset Account mortgages, and others. A brief description of the main types of mortgage is set out below.
Ordinary Variable Rate – is the most common mortgage type and always quoted by all Lenders. It is the basic rate of interest that you pay and it goes up and down during the lifetime of your mortgage loan broadly in line with interest rates in the economy as a whole. When the interest rate goes up, the amount you pay rises and falls when interest rates come down.
Discounted Rate - is an “incentive” offered by Lenders usually off the Ordinary Variable Rate for a period of 1 – 5 years in order to attract your business. On the expiration of the “discounted period” the mortgage usually reverts to the Ordinary Variable Rates. If you repay the mortgage in full or in part during the first few years there is likely to be a penalty, however.
Cashback – is much the same as a Discounted Rate but the Lender gives you a cash payment at the start of the mortgage, which you may need to spend on professional fees and expenses or, indeed, furniture or even repairs or improvements to the property. If you repay the mortgage in full or in part during the first few years there is likely to be a penalty, however.
Capped Rates – ensures the amount you pay will not exceed an agreed maximum but your payments will vary below this level. Capped Rates are usually set for agreed periods of time. If you repay the mortgage in full or in part during the first few years there is likely to be a penalty, however.
Fixed Rates – guarantees the interest rate you pay for a specific period. This can be very comforting if you have a larger loan or you are on a tight budget because it guarantees your payments will not increase. However, if interest rates fall, your payments remain the same. You must think carefully how long you want a fixed rate before you commit yourself. When the fixed rate has expired your mortgage will generally revert to the lender's Ordinary Variable Rate. If you repay the mortgage in full or in part during the first few years there is likely to be a penalty, however.
Flexible Mortgages – are now available and you generally make larger regular repayments than actually necessary and, perhaps the occasional lump sum, thereby reducing the outstanding balance quite significantly. Accordingly, as the interest charged is adjusted monthly, rather than annually as with most lenders, the following repayment not only repays the interest due but reduces the capital even more.
Generally speaking, a notional amount of “overpayment” is calculated and, in the event of you needing this at any time, it is available without any underwriting or application forms.
You may therefore credit your cash savings to your mortgage account, which will reduce the amount charge for interest thereby allowing a further sum from your usual monthly repayment to reduce the outstanding balance.
Offset Mortgages – these are a modern development of a Flexible mortgage. Typically you will open a current account and a savings account with the same lender when you open an offset mortgage account. Your monthly salary is paid into the current account. The lender will only charge you interest on the amount of the mortgage outstanding less any funds in your current account and your savings account. Assuming that your current account is never overdrawn, and/or that you have some savings, this reduces the interest due to the lender. You can either arrange to keep your monthly mortgage payments at the original level, in which case the mortgage will end up being paid off earlier, or you can arrange to keep to the original mortgage term, in which case your monthly payments will reduce.
Flexible Mortgage and Offset Mortgage schemes can appear somewhat complicated until you look more closely at them. Then they appear quite straightforward and you wonder why you had not considered them previously! Why have your emergency savings in a deposit account earning interest at, say, 5.00%, but be subject to income tax, whilst you pay 7.00% or more in interest on your mortgage out of your after-tax income?
REPAYING YOUR MORTGAGE
Now let’s deal with the methods of repaying a mortgage.
Essentially, there are two methods of repaying your mortgage, Capital & Interest (which is commonly referred to as an ordinary Repayment Mortgage), and Interest Only, normally with a mortgage-linked investment alongside such that the investment will repay the mortgage at the end of the mortgage term. Typical mortgage-linked investments include an Endowment, a Personal Pension Plan, or regular contributions into an Individual Savings Account (ISA), although there are others.
A Mortgage Protection Policy or Term Assurance Policy usually covers the mortgage debt against death, neither of which have any investment element.
Whilst the loan will be completely repaid at the end of the agreed term, if you decide to move house or re-mortgage in the early years the loan will probably have reduced only by a small amount.
INTEREST ONLY is where the homeowner repays the interest on a monthly basis to the lender and plans to repay the capital at the end of the mortgage term with the proceeds from one or more investment products.
The methods of repayment of capital could be by an ISA or a Personal Equity Plan (PEP), an endowment policy, a Personal Pension Plan, other investments, an inheritance or even through the sale of the house.
Clearly an interest only mortgage requires careful thought and it is essential to fully understand the requirement of repaying the sum borrowed at the end of the mortgage term as well as putting in place specific plans to do so. With an Interest Only Mortgage it is therefore your responsibility to establish and maintain some kind of savings or investment plan throughout the mortgage term to meet this commitment. Alternatively you should clearly understand that the property may have to be sold at the end of the term of the mortgage.
The mortgage debt is usually covered against the event of death by a Term Assurance Policy.
With an ENDOWMENT mortgage the homeowner pays the mortgage interest on a monthly basis to the lender and arranges an endowment policy with an insurance company to repay the amount borrowed by or at the end of the agreed mortgage term. The amount borrowed remains the same throughout the mortgage term but the endowment policy grows in value as monthly premiums are invested over the years. Unless stated by the insurance company in writing, an endowment policy is not usually guaranteed to meet the mortgage debt at the end of the agreed mortgage term, so there is an element of investment risk.
Generally speaking, endowment policies are somewhat restrictive in that they should run the full term for maximum benefits. The endowment does, however, incorporate life cover and can be extended to provide other benefits such as critical illness cover and total permanent disability. Remember that 20 or 25 years (the typical term of a mortgage) is a long time to plan ahead.
Endowment policies include life assurance (and can include Critical Illness insurance), so there is no need for a Term Assurance policy in addition.
With a PENSION LINKED mortgage the homeowner repays the interest on a monthly basis to the lender and arranges a pension plan which will provide an amount of tax free cash at retirement (between ages 55 and 75, currently) equivalent to the mortgage. The amount borrowed remains the same throughout the mortgage term but the pension fund grows as the monthly contributions build up over the years. This is a more tax efficient method of repayment than endowment as the contributions enjoy tax relief, and the pension fund grows without any charge to tax. Under current legislation you can only use up to 25% of the pension fund as a tax free capital sum. This sum is used to pay off the mortgage.
The mortgage debt is usually covered for the event of death by arranging a Term Assurance Policy.
Generally speaking, as time passes by, homeowners prefer to retain their rights to the tax free cash at retirement and change methods of repayment when moving house or re-mortgaging.
If your circumstances change you may no longer be eligible to contribute to a pension plan and may have to switch to a different repayment method. The tax free lump sum is not guaranteed and may not be sufficient to repay the mortgage in full. Using your pension to repay your mortgage will reduce your pension income.
You are advised that your home is at risk if you do not keep up repayments on a mortgage or other loan secured on it.
Please note that mortgages are regulated by the Financial Services Authority
The subject of DSS assistance in respect of mortgage arrears through sickness, accident or unemployment has been widely publicised. Since 1st October 1995 borrowers with new mortgages or re-mortgages receive 100% of interest payments (subject to a maximum loan of £100,000) only after 9 months where no benefit is paid. Previously (this continues for existing mortgages taken out prior to 1st October 1995), after two months where no benefit was paid, the DSS would pay 50% of interest for 4 months and 100% thereafter. Please read the following page on Mortgage Payment Protection Insurance.
Mortgage Indemnity Guarantee/Mortgage Security Fee. If your mortgage represents a high percentage of the price or valuation of your property (usually 75% or more), you may have to pay a high percentage lending fee. Some or all of this fee may be used by the lender, at its discretion, to obtain mortgage indemnity insurance to act as extra security for its sole benefit. If this is the case, the lender will give you a written explanation, stating that:
Such insurance will not protect you if your property is subsequently taken into possession and sold for less than the amount you owe;
You will remain liable to pay all sums owing, including any arrears, interest and your lenders legal fees;
If a claim is paid to your lender under such insurance, the insurers generally have the right to recover this amount from you.
Redemption Charges. On redeeming a mortgage, the Lender will normally charge a Sealing Fee of about £150. If you have enjoyed an incentive of a discount, cash-back or capped mortgage you may also suffer an Early Redemption Penalty (ERP) if redemption takes place before a number of years have expired – typically five years. It may well be, however, that by arranging a new mortgage with the same Lender will enable the ERP to be repaid.
There may be other fees or charges that you will need to pay. These include:
Reservation Fee - In some cases, especially for new homes, you may be expected to pay a reservation fee or deposit. You should check whether this is returnable or not and obtain a receipt from the builder, the developer or their agent.
Booking Fee - Depending on the mortgage you eventually choose, some lenders may require an arrangement fee to set up the loan. This is usually the case where a fixed rate mortgage or a discounted rate mortgage is involved. Where there is a charge, we will advise you of these costs in advance and confirm in writing.
Arrangement Fee - Depending on the mortgage you eventually choose, some lenders may require an arrangement fee to set up the loan. Where there is a charge, we will advise you of these costs in advance and confirm in writing.
Valuation Fee - Before a lender will offer you mortgage funds, it will usually require a qualified surveyor to inspect the property and to submit a valuation report. This is to ensure that the property is suitable for the loan requested; the report does not necessarily give you an indication as to the condition of the property. If the property is new and building not completed, you may have to pay an additional fee for a second valuation when it is finished.
Survey Fee - In addition to the valuation fee, you may wish to have your own survey carried out by a qualified surveyor; this can take the form of a 'Home Buyers Report' or 'Building Survey'. Most lenders will allow you to have this carried out at the same time as the valuation report, thus saving you money.
Legal Fees - Your solicitor or legal adviser will make a charge for both the sale and purchase or remortgage of the house. We may be able to obtain preferential terms.
Land Registry Fee - This is a once-only charge to reimburse your solicitor or legal adviser who carries out the registration work on your behalf.
Local Authority Search - This procedure, carried out by your solicitor or legal adviser, is to check whether any official plans, decisions or restrictions affect the property you intend to buy. This may take some weeks.
Bankruptcy Search - Your solicitor or legal adviser will undertake on behalf of the lender a bankruptcy search on you and your partner immediately prior to completion of the purchase.
Stamp Duty - This is a Government tax imposed on most purchases of properties.
Telegraphic Transfer Costs - It is usual for the lender to transfer your mortgage funds to your solicitor's or legal adviser's bank by telegraphic transfer. A charge for this will be added to your final account.
Mining Search - If you live in an area where mining has been or is likely to be carried out, the lender may request your solicitor or legal adviser to carry out an appropriate search on its behalf.
Estate Agent Fees - If you are selling your house through an Estate Agent, their fee will normally be paid by your Solicitor or legal adviser on your behalf from the sale proceeds. Estate Agent's fees are not payable when you are buying a house.
The purpose of this type of insurance is to protect your monthly mortgage payments. If you are unable to work due to unforeseen circumstances such as Unemployment, Sickness or Injury you may make a claim to meet your mortgage payments (and possibly other Mortgage Related Costs such as life assurance plus up to 25% of this sum to cover Council Tax, Heating and Lighting Bills, depending on the terms of the policy).
Mortgage Payment Protection is becoming increasingly popular so if you have a mortgage or you intend moving home or buying for the first time, you should give serious consideration to this form of protection. You might also consider Income Protection insurance which is usually referred to a Permanent Health Insurance or PHI.
For example, you may wish to take out a Mortgage Payment Protection for Unemployment Cover only as your employment contract provides for an income for 1, 3 or 6 months in the event of any incapacity through sickness or injury. You may then make an Application for a more comprehensive PHI Policy to cover incapacity on an open ended basis right up to retirement.
Essentially, the reason for such a strategy would be that Unemployment is hoped to be a short term problem whereby up to 12 months benefit should be (and hopefully will be) sufficient but an incapacity may well be a long term condition caused by an accident or critical illness which might prevent re-employment.
Clearly, individual circumstances are quite different and, accordingly, all clients should pay serious attention to this subject to ensure the most appropriate package of protection is taken which will have considered costs and benefits.
We would be happy to provide you with information on this type of insurance. Should you take up a mortgage payment protection insurance arranged by ourselves, we will receive commission for introducing this business. Alternatively many lenders offer Mortgage Payment Protection insurance.