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GUIDE TO MORTGAGES


This guide aims to give you a simple overview of the various types of mortgage available to you and how they work.

1. Who Provides Mortgages?

For years Building Societies were the main suppliers of mortgages, but with the flotation of many of the largest into Banks their share has effectively reduced. These ex-Building Societies, often referred to as Bank Assurance companies, have combined with established Banks. Remaining Building Societies have considerable influence both directly and through their specialist subsidiaries. Means of access to providers has also changed and much mortgage processing is now from centralised points. Whilst all this means potentially more choice in lenders, rates and products, inevitably there is a greater need to assess and understand the individuals needs and requirements.

This is where Grosvenor Trust & Savings, as an independent mortgage broker, can independently assess your needs and requirements and seek to match you to a lender and product to suit. We are not limited or tied to any one mortgage provider and remain independent, concentrating on our clients needs.

 

2. Types of Mortgage

There are two types of mortgage - Capital and Interest Repayment and Interest Only.

a) Capital and Interest Repayment Mortgages
With a repayment mortgage, each of your monthly payments throughout the mortgage term comprises both capital and interest. The advantage of this type of mortgage is that, provided you keep up the repayments, you can be certain that your mortgage will be fully paid off at the end of the term.

Repayment mortgages are more flexible than interest only - it may be possible to extend the term or agree with the lender to defer repayments over a certain period, for example.

Generally the cost of a repayment mortgage is less than the cost of an interest only mortgage if the associated investment and additional interest is taken into account.

For most people a repayment mortgage would be the most suitable choice.

b) Interest Only Mortgages
With an interest only mortgage, you will pay interest on the amount borrowed for the term of the mortgage. The whole of the amount borrowed must be repaid at the end of the term.

Therefore, you must ensure that you have a way of building up sufficient capital during the term of the mortgage to be able to repay it in full at the end. Usually this will be by using some kind of investment into which you make regular payments, such as an endowment policy, Individual Savings Account (ISA) and Personal Pension Plan.

To be worthwhile, the chosen investment will have to produce a return which is greater than the sum borrowed and the interest paid on the mortgage and any tax liability arising on the investment. The major downfall with relying on an investment to repay your mortgage capital is that there is no guarantee you will have enough to repay the full amount when it is due. Relatively poor performance could mean that the amount available from the investment will be insufficient to pay off your mortgage, and will subsequently cost a lot more in interest.

 

3. Interest Only Mortgages - Associated Investments

Essentially, any investment that could be used to accumulate a capital sum could be used in association with an interest only mortgage. However, some lenders do restrict the options available to their borrowers. The most common types of investment used are listed below.

Please note however that with any of these types of investment there is no guarantee that full repayment of the mortgage will be possible from the proceeds of the investment at the end of the mortgage term.

a) Endowment Policies
An endowment policy basically means that you pay premiums to an insurance company, which then invests your money and, after a set period of time, pays you back a lump sum. The size of the lump sum will depend on how much you paid and what type of endowment you have. There is also an element of life cover included. The insurance company will take certain charges from your money during the period of the policy.

i) Without Profits Endowment
These provide a guaranteed amount on death or on maturity of the policy ('sum assured'). This amount will not increase or decrease so you will know that, if you keep up payment of the premiums, you will have enough to repay your mortgage at the end of the term. However, they are unpopular because they are regarded as poor value for money. They are relatively expensive for the return that you eventually receive.

ii) With Profits Endowment
Again, a certain amount on death or maturity is guaranteed. As well as that, you also have a right to a share in the profits made by the insurance company on all their endowment policies. This means that you are likely to receive a surplus amount of money on maturity, after your mortgage has been paid off. However, this is not guaranteed and depends on investment performance. The premiums for with profits endowments are expensive.

iii) Low Cost Endowment
With low cost endowments, the sum assured is lower than the amount of the mortgage that must be repaid. The insurance company assume a growth rate for your money which, if achieved, will result in a bonus sufficient to repay your mortgage on maturity, when added to the sum assured. There is therefore a high risk that there will not be sufficient to repay the mortgage when required and you would have to somehow meet the shortfall with your own funds.

'Low start' versions of these are also available, where the premium starts off lower than it should be and increases over 4-5 years to a level premium which will be charged for the rest of the term.

iv) Unit Linked Endowments
The premiums are used to buy units in investment funds run by the insurance company. Initial projections in the policy quotation are based on assumed growth rates but the actual maturity value will be the total value of the units at the maturity date. The unit price is determined by the value of the underlying assets and can therefore decrease as well as increase. Again, there is no guarantee that there will be sufficient to repay the mortgage when required.

b) Personal Pension Plans
If a personal pension is used in conjunction with an interest only mortgage, then the mortgage will be repaid at the end of the term, using the tax free cash sum available at the time benefits are taken under the pension.

The main advantage of using a pension in this way, particularly if you are a higher rate taxpayer, is that it is a tax efficient way to repay a mortgage. However, a major disadvantage is that there is no guarantee that the cash sum available will be sufficient to repay the mortgage and there could be a shortfall. It also dilutes pension planning because there are then less funds available from which to pay your pension.

c) ISAs
ISAs do not have fixed terms and contributions to them can be varied as much as you want (subject to the maximum contribution limits). They are therefore very flexible to use in conjunction with an interest only mortgage. They are also a very tax efficient method of saving. However, because of their flexibility, you must have the self-discipline to maintain sufficient contributions over the mortgage term. The sum available at the end of the mortgage term depends on investment performance and may not be sufficient to repay the whole mortgage.

 

4. Summary - Capital and Interest Repayment v Interest Only

Repayment:

  • Cheapest way of repaying
  • Guaranteed to repay your whole mortgage
  • You will build up equity in your home as you pay

Interest Only:

  • More expensive
  • Risk with most associated investments that there won't be sufficient to repay your mortgage at the end of the term
  • Possibility of some surplus funds at maturity

 

5. Mortgage Interest Rate Options

There are many different types of interest rate option and which one suits you will depend on your personal circumstances. The main types are listed below.

a) Variable Rate
The lender will vary the rate charged from time to time in line with market conditions. This will cause the amount of your monthly repayments to change.

b) Fixed Rate
The interest rate will be fixed at the start of the mortgage for a set period, usually 2 - 5 years. The fixed rate mortgages available at any time will depend not only on current but also future expectations of interest rate movements. A fixed rate provides you with a definite monthly repayment amount for the duration of the fixed period.

c) Discounted Rate
This is a variable rate (see above), but where the interest for an initial set period of the mortgage is charged at a lower variable rate than normal (e.g. 2% below normal variable rate). Typical set periods will be between 2 - 5 years.

d) Tracker Mortgages
This type of mortgage is a variable rate mortgage where the interest 'tracks' an index (usually bank base rate). Bank rate changes influence all variable rate mortgages, but tracker mortgages have an automatic link built in. Control of the rate is effectively removed from the lender until the agreed period comes to an end. These can be for the life of the mortgage or as part of an initial incentive period (e.g. 2 - 5yrs typically).

e) Capped and Collared Rates
This is a variable rate mortgage. However, a capped rate mortgage specifies the maximum interest rate that could apply for a set period and a collared rate mortgage specifies the minimum rate that could apply. They are often used together. This is a method of limiting interest rate fluctuations without fixing them entirely. The level of repayment due from you is therefore reasonably certain.

f) Cashback Mortgages
This is not actually an interest rate option. With a cashback mortgage, you receive a cash bonus when your mortgage completes, as an incentive to choose that lender. With significant numbers of cashback mortgages expect to be tied in with penalties for a number of years at the lender's normal rate.

g) Flexible Mortgages
Some lenders are now offering mortgages that give you far wider options with regard to your repayments than ever before. This is a response to the fact that, generally, people's circumstances change more frequently nowadays.

More recently there has been a growth in Offset Mortgages where your savings / current accounts are linked to your mortgage. This means that whilst your savings attract no interest, amounts held will 'offset' the mortgage interest charged with resultant savings. Offset mortgages can be simple savings related schemes or more comprehensive current account solutions.

Variations and Combinations

Many of the above products can be combined. Recently lenders have introduced discounts and trackers where the initial start rate is very low but in later years they reduce the discount given and increase the costs. This is common with 3 year deals and there are many variations. This can also extend to fixed rates, with the initial fixed period being followed by a higher fix or a switch for a time to some form of variable tracker / discount. These are commonly known as stepped schemes.

Very low rates usually come with extended penalty overhangs. This means once the product has ended you will typically pay a much higher rate but cannot exit without paying a significant penalty.

Here at Grosvenor Trust & Savings we can help guide you through the above products, looking at your needs now and for the foreseeable future.

 

6. Points to Note

Depending on the type of mortgage you choose, there are often special conditions imposed of which you should be aware.

These are generally in the form of early repayment charges and are usually expressed as a percentage of the loan. If you move lenders or repay part, or all, of your mortgage within the time period specified then you will have to pay a penalty to the lender.

If your mortgage exceeds a certain percentage of the property value then you may be asked to pay a Higher Lending Charge. When a lender lends money, their major concern is to avoid losing the money. To reduce this risk, the lender may take out insurance (mortgage indemnity policy) to cover loans where a high percentage of the property value is being loaned, the cost of this is the Higher Lending Fee.

Other charges may also be made by the lender, such as an arrangement fee and survey fee.

 

7. The Mortgage Process

The typical stages involved in arranging a mortgage are as follows. The steps will be similar apart from finding a suitable property if you are remortgaging:

a) You decide on the price range of the property you want to buy

b) We find you a lender suitable for your needs who will give you an 'decision in principle' to lend to you. This does not bind the lender to lending you the money. The final decision will depend on the results of a valuation on the actual property you wish to buy and also on you being able to substantiate the information you have provided to the lender (e.g. you may be asked to provide pay slips or accounts)

c) You find a property to buy

d) You instruct a solicitor to deal with the purchase. The solicitor will usually also act for your lender to complete your mortgage. We can recommend a solicitor from our nationwide panel of on line legal/conveyance firms if required.

Or click on this link where you can get an immediate quote and instruct a solicitor

econveyancer

e) We usually meet with you, take further details and send a full mortgage application to the lender

f) The lender processes your application, raises any queries and arranges a valuation of the property. You may wish to instruct your own survey as you will not be able to rely on the valuation arranged by your lender as this is purely to establish that the property is a suitable security for their lending and not a buildings survey.

g) If all is well, your lender confirms the loan by issuing a formal offer of mortgage.

h) We arrange any insurance that you may need

i) Your solicitor will in the meantime investigate title to the property and carry out the necessary searches

j) Once search results are available and you have a mortgage offer, your solicitor will report to you and exchange contracts. At this point the date for completion is set

k) We put in force any Insurances we have arranged for you.

l) Your solicitor will prepare the final documentation and draw down your mortgage advance

m) Completion day - all monies paid and you can move in

 


 
 

Protect Your Mortgage Payments

 

Melwoods Chartered Certified Accountants

   

2009
CCBA
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