Mortgages
Financing your home can be a daunting prospect especially to First Time Buyers. Below are explanations of the different types of mortgages you can choose from as well as some of the terminology explained. If you would like to discuss anything further with one of the Financial advisors please phone us today on 020 7328 3280.
Repayment Mortgage
A repayment mortgage is one where you pay off both the original loan and the interest on that loan via monthly payments to the lender.At the start of the mortgage, your monthly payments consist of mainly paying the interest and only a small amount of the original loan. The further into the mortgage term you go, the more of the loan repayment gets paid off each month so you own more of the property.
Interest Only Mortgage
A interest-only mortgage is one where you only pay the interest on the loan month by month, and still owe the lender the whole of original sum borrowed until the end of the mortgage.Therefore, as well as a monthly payment to the lender, you make a second monthly payment into some sort of investment vehicle (such as an endowment, ISA, or pension). The idea is that at the end of the mortgage the investment vehicle contains a sufficient sum to pay off the original loan - possibly even a some left over.
Fixed Rate Mortgage
A fixed rate mortgage is one where the interest rate on the loan remains constant.In the UK mortgages can only usually be fixed for the first few years (e.g. up to 5). Mortgages which have a fixed rate for their entire term are common in other countries, but are only beginning to appear in the UK.
Capped Mortgage
A capped mortgage is one where the interest rate on the loan cannot rise above a certain level.In the UK a capped rate, like a fixed rate, is only usually available for the first few years of the mortgage (e.g. up to 5).
Types of interest only mortgage
There are three main types of interest-only mortgage - in other words, three main types of investment vehicle which are used to pay off the loan. It's worth bearing in mind that none of these is guaranteed to pay off the loan, and you need to keep a careful eye on the value of the fund and be prepared to top it up as necessary.The first type of vehicle is an endowment. The major benefit is that the endowment also includes life cover, which therefore doesn't have to be arranged separately. The major problem with endowments is the charging structure: if you have to "close" the endowment early its value may be substantially less than the amount you have paid in.
The second vehicle is an ISA (previously, PEPs). ISAs are explained in greater depth elsewhere, but the key benefit is that the money you pay in grows free of tax (other than tax credits on dividends). The major disadvantage is one of lost opportunity - you can only pay in a certain amount to ISAs each year, and if you are using this to pay off your mortgage you are losing the ability to make tax-free savings.
The final way to pay off an interest-only mortgage, and by far the least common, is using a pension. Most forms of pension fund let you take 25% of their value as a tax-free lump sum at retirement. The idea behind pension mortgages is that you are paying off the loan not only using a fund which grows free of tax (like an ISA), but you are also effectively getting tax relief on your mortgage contributions as well. The problem is a distinct lack of flexibility, and the fact that you can't pay off the mortgage before retirement.
What types of interest rate are available?
Having decided between repayment and interest-only mortgages, you're then faced with a second decision. What sort of loan do you want?The simplest is a variable rate. The rate of interest on your mortgage, and therefore your monthly payments, simply goes up and down according to whatever interest rates currently are in the economy at large. The only problem is that this variation can be very wide. If interest rates move from 5% to 15%, which has happened within the last ten years, your monthly payments triple.
Strangely, many borrowers don't like the prospect of this happening, and are therefore attracted by two sorts of guarantee which lenders offer: fixed and capped rates. A fixed rate mortgage is what it says: the interest rate is set at a certain level, and therefore so are your payments. A capped rate is slightly more complex: there is a maximum level above which your payments can't rise, but they can also fall if prevailing interest rates fall below the cap.
On a 25-year loan these guarantees are quite dangerous for lenders to make. They have major problems if prevailing interest rates are 15% but they have fixed or capped people's mortgages at only 5%. In fact, they would go out of business. Therefore, fixed and capped rates are only usually available for the first few years of a mortgage (up to 5 years), after which the mortgage switches to the normal variable rate.
The other short-term incentive which lenders offer is discounted rates. Your payments are variable, but you get a discount off the standard variable rate. Once again, this discount is only for a limited period.
These short-term incentives only make commercial sense for the lender if you stay with them beyond the point at which the incentive ends. Therefore, there are almost always stiff early-payment charges (redemption penalties) if you try to pay off a fixed, capped or discount mortgage before the incentive period ends.
If the range of products on offer were not already confusing enough, there are two other incentives which have become popular in recent years.
The first is "cashback", which is not fundamentally different to getting cashback at a supermarket. You take out a loan with a lender, and they give you not only the amount you are borrowing, but a bit more as well. This can be used for home improvements, furniture, a party etc. Ultimately, of course, you are paying for this cashback in one form or another. There's no such thing as a free lunch.
Finally, there are "flexible" mortgages, increasingly driven by new technology and its ability combine many different financial schemes in one place. In a flexible mortgage your mortgage loan is combined with other sorts of debt such as credit cards, and sometimes even with your current account. The idea is that the rate on a flexible mortgage may be slightly higher than the standard variable rate, but you benefit from lower rates on your credit cards and from earning interest on your current account.
Types of insurance
It is important to protect your home and its contents from damage, fires, flooding, theft etc. One of the pre-requisites of getting a mortgage is that you have to have buildings insurance in-case your house burns down, they want the guarantee they will get the money back.There are many companies out there who offer buildings insurance, many offer buildings and contents insurance combined, the Post Office, supermarkets, your mortgage lender, insurance companies like Direct Line.
It is also advised to consider life insurance, critical illness insurance and accident insurance which disables you to work. You can discuss all aspects about insurance in depth with a member of Greene Financial Services.
Telephone Greene Financial Services on 020 7328 3280 or visit the website.
Greene & Co Estate Agents are not authorised to advise on mortgages or investments and instead introduce clients to Greene & Co Financial Services which is the trading name of Prudell Ltd who are authorised and regulated by the Financial Services Authority.