What is a Mortgage?

In simple terms, a mortgage is a sum of money borrowed from a lender which is secured against a property. The lender charges interest on the sum outstanding and will require the borrowed money to be repaid at some stage.

There are two types of mortgage: A Repayment Mortgage or an Interest Only Mortgage.

A Repayment Mortgage:

Also commonly known as a Capital & Interest Loan. Over the term of the loan, both the interest and the capital are repaid to the lender. The lender calculates the required monthly payment in order that the loan is fully repaid over the term. In the early years of the loan, the bulk of the monthly payment is made up of interest.

An Interest Only Mortgage:

The borrower pays the lender the interest payment, hence the “interest-only” bit. The borrower is responsible for finding a way of paying off the debt at the end of the term. Most types of investments may be used to do this such as an ISA, Pension Lump Sum or an endowment etc. Borrowers could also sell the home to raise the capital to repay the lender.

You can also have a combination of the two different types of mortgage which is known as Mix Match: This is a combination of a repayment mortgage and an interest only mortgage. The right level of life insurance and/or critical illness cover should be considered to adequately protect the debt.

Discounted Variable Rate:

This refers to the interest rate being charged on the loan and is based upon the Standard Variable Rate, less a fixed discounted percentage. An example of a discounted variable rate is: “1% off the Standard Variable Rate for a period of 2-years”. Lenders use these types of deals to attract new customers such as first-time buyers or remortgages from other lenders.

Fixed Rate Mortgage:

A fixed rate mortgage sets the initial interest rate at a certain level fixed for a specified period. An example of a fixed rate is: “6% fixed for 3-years”. Regardless of any interest rate changes within the fixed rate period, the fixed rate does not change, giving borrowers the certainty of being able to budget for their monthly payments. At the end of the fixed rate period, borrowers usually revert to the Standard Variable Rate or then may be offered a further fixed rate deal. At the end of their fixed rate deal is a good time to shop around for another deal.

Capped Rate Mortgage:

Similar to a fixed rate, but with the added advantage that if the Standard Variable Rate reduces, the mortgage payment also comes down. An example of a capped rate is: “6% capped for 3-years”. If the Standard Variable Rate at the time were say, 6% then, 6% is what that borrower pays. If rates went down to say, 5%, then the borrower's monthly payment would reduce accordingly. If rates went up to say, 8%, then the borrower would pay 6% only, being the capped amount. Capped rate offers are relatively rare and often the “cap” can be higher than say, a fixed rate mortgage deal...

These types of deals work on the basis that the mortgage lender offers a deal which “tracks” say, the Bank of England base rate. An example of a Tracker is: “1% above the Bank of England base rate for 3-years”. They have become popular due to their apparent fairness. Customers want to ensure that their lender is not manipulating their Standard Variable Rate for their own gain. A Tracker mortgage, will not allow the lender to delay interest rate cuts when the Bank of England reduces the main base rate. Historically, lenders have been quick to increase rates as the Bank of England announces increases and slow in the opposite direction. Trackers help to resolve this unfairness.

Early Repayment Charge (ERCs):

On many mortgages there is an Early Repayment Charge which is payable if the home loan is paid off within a predetermined period. Early Repayment Charges are also known as “Redemption Penalties”. For example, if a customer had a fixed rate loan deal for three years, and then repaid all or part of the loan within that period, the lender may charge an ERC. It is therefore important to check carefully whether such an ERC applies to the mortgage deal under consideration. It is also worth checking to see whether the deal is “portable”, i.e. that the mortgage can be moved to another property if there is a possibility of moving home within the term of the chosen mortgage deal.

Booking / Arrangement Fees:

Lenders commonly charge up-front Booking or Arrangement Fees for discounted and/or fixed / capped mortgage deals. These fees can be added to the loan or must be paid up-front. Look carefully at the deal under consideration and check the costs.

Valuation Fees:

Virtually all mortgage lenders require a property valuation. This is to ensure that the mortgage lender is not lending too much in relation to the actual value of the property. The basic valuation is for the lender’s benefit. It may also include a further “admin fee” to cover the costs of arranging the valuation. This type of basic valuation does not represent a detailed inspection of the property. Borrowers are advised to opt for a more expensive “Homebuyer's Report” or a “Full Structural Survey”. Provided the valuer who is inspecting the property is suitably qualified, they can undertake both the valuation and the more comprehensive survey.

Legal Advice:

It is common for both the lender and the customer to have a solicitor or licensed conveyancer to act on their behalf during the property transaction. It is the role of the solicitor/ licensed conveyancer to note the proposed ownership of the property on the title deeds, note the lender’s interests, deal with the Land Registry and undertake searches to ensure that there are no adverse factors which could affect the property. Often, lenders will have tie-ups with solicitors/licensed conveyancers or the borrower can choose their own. Word of mouth referrals are often the best source of a good lawyer, but it is prudent to get an estimate of the costs beforehand.

Higher Lending Charge (HLC):

This was previously known as a Mortgage Indemnity Charge and is applicable where a customer is borrowing a high percentage loan in relation to the value of the house, say, 95%. The HLC is designed to protect the lender, rather than the customer, but, the lender expects the borrower to pay the premium. The HLC acts as a type of insurance for the lender. In the event that a borrower has difficulties in repaying the mortgage payments and the home is repossessed, if the property is sold for less than the outstanding debt on it, the insurance policy protects the lender. As the insurance covers the lender rather than the borrower, they are still liable for any sums outstanding on the transaction, which could include legal fees and bailiffs etc. It is the insurer who may pursue the borrower, rather than the lender.

Endowment:

This is a type of life insurance which is used to support an Interest Only Mortgage. The most common is the Low Cost Endowment. An Endowment provides life insurance, which is known as the Guaranteed Death Benefit. If the policyholder were to die within the term of the Endowment, this is the sum which would be paid out by the life insurance company (provided of course that the premiums are up to date). In addition to the Guaranteed Death Benefit, most Endowment policies act as a form of long-term savings plan, the theory being that over the term, the premiums pay for the life insurance and the rest is invested so that over the term of the endowment policy, savings accumulate in order that when the policy matures, a lump sum is paid out. This may, or may not be sufficient to pay off the mortgage depending upon how well the investments have grown. It is important to check carefully whether the Endowment will be “on-target” to pay out a sufficient lump sum. In the early years, the surrender values can be significantly less than the premiums paid. Over the last few years, the payouts on Endowments have reduced dramatically, largely due to poor investment conditions and low inflation. Endowments have received bad publicity and have fallen out of favour. There are still many Endowment policy holders in the UK and it is a common type of interest only Mortgage repayment savings vehicle. Very few new endowment policies are now being purchased.

ISAs:

Are another form of investment which can be used to support an Interest Only Mortgage. Life insurance to protect the loan is not included with an ISA and some form of life cover may need to be considered separately to protect the debt.

Buildings Insurance:

If a mortgage lender has a debt which is secured on a property, they will want to ensure that the property is adequately insured. This will be a condition of the loan agreement. Buildings Insurance will cover the fabric of the house against fire, flooding, storm damage etc. Mortgage lenders often insist upon reviewing the Buildings Insurance prior to the completion of the home loan and many lenders offer their own “in-house” policies. Again, as with any form of insurance policy, it is always worth shopping around for a competitive quote and comprehensive cover.

The Mortgage Code of Practice is a voluntary code of practice that we and most UK mortgage lenders subscribe to and endorse. The main commitments of the code are that lenders and intermediaries will:

• act fairly and reasonably at all times;
• make sure that all services and products keep to the conditions of the code, even if they have their own terms and conditions;
• give you information on services and products in plain language, and offer help if there is any area which you do not understand;
• help you to choose a mortgage to fit your needs, unless you have already decided on your mortgage;
• help you to understand the financial effects of having a mortgage;
• help you to understand how your mortgage account works;
• make sure that the procedures staff follow reflect the commitments set out in the code;
• correct errors and handle complaints speedily;
• consider cases of financial difficulty and mortgage arrears (missed payments) sympathetically and positively; and make sure that all services and products meet the relevant laws and regulations.

The Council of Mortgage Lenders:

Is the trade association for the mortgage lending industry, and their members account for around 98% of UK residential mortgage lending. Their members include banks, building societies and other mortgage lenders and their aim is to help to foster a favourable operating environment in the UK housing and mortgage markets. They are the representative voice for the residential mortgage lending industry, and the central provider of economic, statistical, legal, research and other market information. Their website is: http://www.cml.org.uk.

THINK CAREFULLY BEFORE SECURING DEBTS AGAINST YOUR HOME. YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE.