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Mortgages confuse many people so this is an introduction into the process of arranging a mortgage and buying a house. It should be used in conjunction with advice from the professionals, but will hopefully shed light on some areas often hidden in clouds of jargon.
The first stage is to decide how much you can afford. Too many people do this by deciding how much they can afford to spend each month, finding out how big a mortgage that is, and then basing their house hunting on that figure.
This is a very risky approach when interest rates are low as it can create huge problems if mortgage rates are increased, especially if this coincides with the loss of an income. ( In general terms mortgage interest rate rises occur just before recessions, so this should be taken into account ). For example a mortgage rate rise from 8% to 12% will produce a 50% increase in mortgage payments, which could prove a real problem if the original mortgage was a strain on the budget.
The other problem that arises is the " difficult early years, better later on " idea. There was a tendency in the past for people to borrow for up to the hilt, knowing that life would get easier in the future as the value of the house grew and the mortgage became less onerous. This was actually a side effect of inflation, and interest rates that were, after tax relief, actually negative in real terms. High inflation of 6-10% pa pushed up house prices, and wages, but the debt ( i.e. and therefore mortgage repayments) stayed the same, making it seem cheaper as time went on, ( an effect enhanced by net mortgage interest rates that were less than inflation). But with little or no inflation, and mortgage rates that are greater than inflation, house prices will only rise in response to wages, which will only rise in response to better performance and promotion. The effect of this is that borrowing to the hilt is a very bad idea UNLESS you are sure that your income will increase rapidly in real terms.
In short do not ask how much you can borrow, but decide how much you are prepared to pay per month assuming a highish interest rate, ( e.g. 12% ), and use that as your limit. Expect to pay a mortgage rate of 8% to 10% most of the time, but be prepared for 12% at times, and at others, enjoy lower rates. If rates are low at the time you borrow do not be lulled into a false sense of security and get overextended.
Use this calculator to see how much the monthly Interest payments are for a given
houseprice.
You have found the ideal house and will settle for no other. If the price is too high offer what you can afford and make it clear that it is not a negotiating ploy but a simple upper limit. They can then agree or not.
But most people can find a number of suitable properties. Now the ball is in the court of the buyer. Make offers that you consider fair, and walk away. If one of the sellers needs to sell then they may accept a lower price than their ideal.
Be aware that the sole aim of the estate agent is not to help you buy a house, it is to SELL his clients property to the highest offer. In active markets gazumping is part of the game, ( after all, if you are a seller you would want the best price ), and in quiet markets some buyers gazunder, ( agree a price, then drop it before committing ). Deals are not binding until contracts are exchanged, ( which normally means that you are vulnerable to a gazump until the mortgage is arranged ).
In Scotland the rules are different. A normal case involves a property being put up for sealed bids, to be made by a due date, all of which are binding. Buyers make suitable survey and mortgage arrangements and make a bid on that basis. The seller then chooses a suitable bid and the deal is binding. ( The highest offer may not win, as the seller may accept a lower offer from someone who binds to complete in a short time. Sometimes other conditions may be stipulated by the seller, or offered in the bid ).
Most lenders like borrowers who have good steady incomes and good steady jobs. They will lend up to 95% most of the time, 100% some of the time and 105% in boom markets, ( or where there is a good reason to believe that the property is undervalued, e.g. right to buy discounts ).
Self employed types should have three years accounts showing suitable earnings, but will normally be limited to 95% even with the best record. Those without should either give up, or have at least a 25% deposit and go for a Self Certification or Non Status mortgage, ( see below ).
For the purposes of a mortgage the purchase price IS the value. If you pay £35,000 you cannot argue that it is really worth £40,000 in order to get a bigger mortgage. I.e. if you can get a 95% loan at £40,000 you will need a £2000 deposit. If the price is dropped to £35,000 you will need a £1750 deposit. If the valuer decides that the property is worth less than the agreed price then the lender will use the lower value. On the other hand such a reduced value can be a good negotiating tool, ( as it normally kills the sale if the vendor cannot reduce the price ).
The other limit is that of the earnings multiple, normally 3 times salary, though higher limits may be offered. In practice it imprudent to borrow to the maximum for reasons discussed above, ( plug the figures into the Interest Calculator for your own position), and if the earnings limits are a problem then it is a sign that you may be overreaching yourself.
The lender will also want a survey completed to satisfy themselves as to the value of the security. Do not rely on this alone, have your own survey commissioned, especially if the property is old or in any way in need of work. Very old and unusual or one off properties should also have a structural survey completed.
Use this calculator to see what sort of loan you could raise.
First we'll examine the Interest Rate options and Status, then look at the repayment systems.
Most mortgages are issued "subject to status ". This means that nothing will be finalised until the lender is satisfied that you are who you claim, and have the earnings to support the loan. In one type known as Self Certification the status checks are reduced and it is up to you to confirm that you can afford the mortgage. Naturally the lender would be taking a big risk lending large percentages on this basis, so you normally have to have a hefty deposit available.
Finally there is "Non Status" in which the lender cares very little about your income, but simply lends you the money. Expect to put up 25% minimum, and more often 30% to 40% as a deposit.
You can see that the Self Cert and Non Status routes place most of the risk on the borrower, as if there is a default the lender will repossess and sell at bargain basement prices. Even in a worst case it is unlikely to have to accept a loss if the buyer put up 30% in the first place. By and large these loans are for those with very variable incomes, or who have suddenly done well for themselves. These loans are also often more expensive than normal and should be avoided if standard ones will suit.
Interest Rate options. You can simply pay the going rate right through the mortgage, ( floating rate ), or take up one of the offers available at the time that you borrow. These offers will usually include some of the following:-
1) Fixed rates. Here the interest rate is fixed for an agreed period. This may range from a very low rate for a few months, to a rate even above the current one for a few years. Low rate deals may be good value, but there might be a sting in the tail if the lenders normal rate is higher than most, and you will have to pay penalties if you switch lenders in the future. Fixing at or near current rates might be wise for budgeting purposes or if you can see rates going up. If you will be stretching yourself, or doing a lot of expensive work on the property a 3 to 5 year fixed rate is probably well worth thinking about.
2) Capped rates. Like fixed rates but if rates fall so does your interest payments. Can be a good deal but their availability depends very much on the derivatives markets. ( Sometimes they simply do not exist for months at a time).
3) Others. Read the small print. It might simply be a fancy name for a normal mortgage, a fixed rate or capped rate, but it may be a more complex and dangerous beast which offers low initial rates but which may be expensive in the long term or even increase the amount of the debt.
This can be done slowly throughout the term, and is known as a Repayment Mortgage, or all at once at the end of the term by means of a separate savings plan, ( either an Endowment or a ISA ). I am not going to cover pension mortgages here as they are unsuitable in most cases.
Use this calculator to see what the costs of the Repayment Option might be. The logic behind using a separate savings plan rather than gradual repayment is based on assumptions about growth, and tax treatment. In a nutshell if tax relief is both offered on investments, and given on interest payments, (note, as of April 2000 interest is only tax deductible in the context of a mortgage that is classed as having commercial purposes. Ordinary housebuyers do not get interest tax relief), then borrowing to invest is a good idea because the real risk is reduced, making it a very attractive proposition. If no tax benefits apply at any point then only those willing to accept the true risk should do so. ( In this case the assumption is that over the long term growth rates will be greater than interest rates. Most professionals consider this to be the case, but most members of the public are more cautious ).
At present the tax structure makes using Endowments and ISAs attractive for long term mortgages of over 15 years. Durations of under 10 should be by repayment, ( unless you fully understand the risks ), and in between in a judgement call.
You will become aware of a debate between the relative merits of Endowments and ISAs as savings vehicles. ISAs are more tax efficient, with lower charges and pay lower commissions than endowments, but you need to buy a separate life insurance policy if needed, (forget about the life element of ISAs, it is not normally suitable). On the other hand the endowment commission was often used to subsidise the rest of the work involved. ( Lenders do not normally pay enough to brokers as introducers to cover the work involved). The upshot is that many advisers will now charge a fee for arranging the mortgage on an ISA basis, unless other business provides suitable commission.
In summary the best 25 year mortgage for an investment oriented person is normally an ISA mortgage with either a floating interest rate, or one fixed for the first few years.
Use this calculator to compare the costs and benefits of Repayment vs Investment based mortgages. Note that the largest rewards arise from being conservative in your assumptions about future investment performance, and the greatest risks arise from being optimistic. That said, if you find yourself with spare capital and use it to reduce your loan, you can make considerable savings. Even paying slightly over the odds can have shave several years and thousands of pounds off your total cost.
This calculator shows the effect of enhanced payments. Hint, use the Monthly Repayment one if you give up guessing...
The final element in the mortgage is the insurance element. You do not need life insurance to raise a mortgage, but it might be wise to have some. The simple question to ask is "what happens if...".
If I die? If I die and no one else needs the house, life insurance is not essential, ( though a cautious person might buy it anyway, just in case of future commitments ).
If I get ill? If getting ill would result in financial hardship then some form of protection should be sought. There are two types of policy, and both are worth having, namely Critical Illness and Permanent Health Insurance. CI provides a large cash sum, ( useful for clearing the mortgage ), and PHI provides an income until retirement.
You might consider using the redundancy cover offered by the lender, but make sure that you could claim. ( Many policies exclude self employed and term contract workers ).
You might find yourself being asked for an Indemnity Guarantee Premium. This is a lump sum payment that insures the lender against loss in the event of your default. It is normally needed on loans over 75%. If the worst happens and you are repossessed please note that you are not protected. The insurer will pay the debt, and then chase you for it. ( You might have heard press reports that indicated that the borrower was protected. New policies do not have this loophole, if indeed it ever existed. ). If the Indemnity Guarentee Premium is an issue you should ask your adviser for mortgages to be listed showing the lowest Indemnity Guarantee Premiums. Sometimes almost identical mortgages are available but with hundreds of pounds difference in the Indemnity Guarantee Premium.
You will need a solicitor to do the conveyancing and searches. Their job is to ensure that the property does not have any nasty surprises, ( e.g. the isolated dream cottage where title does not allow for access for services like electricity and plumbing, or someone else has rights to part of the land, or that there are restrictions on building extensions and garages etc. ).
The solicitors fee will include elements for the charges levied by the various governmental departments involved.
The solicitor acts for you on the legal side.
The estate agent is interested in selling properties. As such he normally has access to a wide range of lenders and can make all the mortgage arrangements. Most of them are tied to one insurance company however which limits their ability to provide a fully competitive service.
The bank or building society. Going direct is normally a waste of good shoe leather as the offers are normally the same as those available through other sources, and you only see a very small number of the options. Most are also tied to one source of insurance and this again can cost over the odds.
The Independent Financial Adviser can access the full range of lenders and insurers, thereby linking the best loan to the best value cover and investment. However they need commission or fees to earn a living and if going for a low commission option, expect to pay a fee. ( The estate agent is of course getting a commission for selling the house). A tip for those who want to get the best of both worlds is to do the savings vehicle and insurances with an IFA, but get the Estate Agent to do the legwork on the mortgage. This is in fact how I arranged my last mortgage, (no longer being a practicing IFA I also have to go through proper channels now).
1) House hunting in a price range that no one will lend to you for. A sad waste of time, and a disappointment if you find your ideal dream home. Make sure that you are being realistic before getting too involved
2) Self employed people who have low profits in the accounts but good income in reality. Hoist by your own petard if you have to prove status. ( You might have paid less tax, but the consequences are a low credit limit ).
3) Mortgage fraud by accident. " But the nice man filled in the forms, and although I know he exaggerated our income he said it was OK, everybody did it ". Don't lie on the form, you only need to lie if you have to exaggerate your income, which means that you probably cannot afford the property, which means that you will fall behind with the payments, which means that it will all come out. You might escape the law, but it'll be hell trying to buy another house.
4) Non declaration of County Court Judgements. You can borrow with CCJs, even outstanding ones, as long as they are declared and the lender can see that they are irrelevant. However not telling the mortgage broker about them will result in everyone's time being wasted, as they will normally get picked up by the standard credit checks that any lender will run prior to issuing an offer.
5) Borrowing more than is wise. See my comments at the start of this essay, and run the Interest Calculator, especially if house prices are rising. Too many people who bought in 87/88 were repossessed or in negative equity by 91/92 having seen their monthly payments nearly double.