A mortgage is something which many young professionals dream of owning (despite it being probably the largest loan you will ever take in your life).
It was reported that while wages rose a meagre 0.6% (including bonuses) last year, the average house price in the UK rose by 11.7%, with London prices rising by 19.1%.
The fact that house prices are rising at a rate of around 20 times the rate of wages is staggering, and indicates that it is getting more difficult to get onto the property ladder.
For those who have managed to save enough for their first deposit, they probably would be overwhelmed by the number of different options that a mortgage offers, and it is for this fact that I have decided to provide practical analysis on the types of mortgage available to potential borrowers. This is essentially a guide to offer help for first time buyers.
The first question you need to consider when looking to take out a mortgage is:
Should I get a Variable Rate, or a Fixed Rate Mortgage?
A fixed rate mortgage is exactly what it sounds like; a fixed interest rate on repayments which means each monthly liable payment is defined once the mortgage has been accepted.
These mortgages usually come with incentive starter rates which run for a percentage of the length of the loan.
The positive of this type of loan is that no matter how high the Bank of England base rate is, you will pay the fixed amount defined by the loan (this could actually make your interest repayments less than the interest rate); however this is also a negative as a fall in the rate will make you worse off.
Fixed rate mortgages usually come with a significant penalty for early repayment, so if you decide to take this type of loan, you are stuck for the duration (unless you pay the hefty penalty, or go bankrupt).
A variable rate loan is a bit more complex than the fixed rate as it usually is linked to a particular index (Bank of England base rate, or even a rate defined by them with a heavy amount of discretion applied). The best current mortgage interest rates for a 10% deposit (or 90% LTV) are 4.19%, so make sure that your monthly budget is calibrated to at least this value.
The interest repayments to service the mortgage vary each month based on the index they are linked against, and are usually cheaper in the long run as they minimise the lenders interest rate risk.
There are three common variable rate mortgages available:
1) Tracker Mortgage
The tracker mortgage uses the Bank of England base rate to link its interest rate for repayments to.
Usually the rate is a certain number of percentage points above the BoE rate (e.g. if the base rate is currently at 0.5%, and the interest repayments specify a repayment rate of 1.5% more than the base rate, then the rate you pay is 2%.
If the Bank of England base rate increases to 1.5%, then you will pay 3%).
The benefit is that your mortgage moves with economic conditions (so a better off economy usually will translate to higher wages for you, so the increased cost shouldn’t be too bad).
However, it is a defined term mortgage, so if the base rate jumps to a very high rate, you could be paying a significant amount more for your mortgage where a fixed rate wouldn’t have.
2) Standard Variable Rate Mortgages (SVRs)
This mortgage usually loosely follows the BoE base rate with about 3% variance, but the conditions of the mortgage state that the rate can be adjusted to anything that the lender wants.
They usually can provide a huge saving on monthly repayments, but as with most financial products, the increased potential return is always accompanied by a similar risk. SVRs aren’t commonly used in the UK as other forms of mortgage.
3) Discount Rate Mortgages
The discount that this mortgage is referring to, is the difference give to the Standard Variable Rate offered in the previous mortgage.
These mortgages can run anywhere from a few months to the lifetime of the individual, and similarly with the SVR, the rate can change at any point with no requirement of any justification.
Once you have decided which type of interest you would like to pay, the next question you must consider is:
Should I go for an Interest Only Mortgage or a Repayment Mortgage?
The repayment mortgage constitutes to a mix of interest, and an amount which actually pays off a portion of the loan.
The way the mortgage is constructed means that each month you pay, the interest repayment will reduce as the outstanding amount isn’t accruing as much interest for you to pay.
Once you are half way through the maturity of the loan, you will not have paid half of the outstanding debt.
An interest only mortgage is just that; after 25 years of paying monthly installments, the amount to pay back at the end of the mortgage will remain at exactly what the loan amount was.
No equity will be built up. These loans are very difficult to take as there needs to be sufficient proof that the entire amount can be repaid at maturity of the loan (or that the debt can be “rolled over” with a new loan).
Between the two, the repayment mortgage is the most financially wise, even if the monthly repayments would be larger than the interest only mortgage. So the third question you need to ask is:
How long should the term of the mortgage be?
A rule of thumb is that shorter mortgage terms will usually translate to lower interest repayments over the life of the loan.
A shorter mortgage term means higher monthly repayments, but you may be able to pay back the required amount each month. It is important to keep in mind that many mortgages have penalties for early repayment.
Some mortgages also offer incentive rates for the first few years (lower interest rates), but the overall repayment structure could mean that the interest repayments of the loan could far exceed the amount which a traditional mortgage with no incentives would cost.
Although probably not an immediate concern for many first time buyers, a lot of mortgage lenders will not allow the mortgage term to be taken into retirement, so the amount you are able to borrow, and term to take the mortgage for can be affected by your age.
Once you have decided on the key characteristics for your mortgage, you can start to look into some of the flexible options that are offered to you when taking out the loan. Some of the flexible features include:
1) Overpayment
If you receive a windfall one particular month, you may feel as though it would be wise financially to pay off an extra amount of your mortgage to reduce the interest payments for future dates.
Unfortunately, there is usually some restriction placed on the mortgage overpayment, whether it specifies an amount over the yearly repayment (up to 10%), or the number of months a year that overpayment is allowed.
Some mortgages even allow the overpayments to be recalled back by the borrower when needed (but this is not common knowledge understandably).
2) Payment Holiday
Some mortgage lenders will allow you to take payment holidays, which means delaying payment for a month or two until you are able to pay.
Usually the terms require you to have overpaid the mortgage in previous months, and the interest payment missed out will be added to future payments. It is a great feature as a last resort, but as with everything, there is no such thing as a free lunch.
3) Offset Mortgages
Some mortgages allow you to use the loan as a place to store your savings (which can have additional benefits when it comes to interest).
If you have a £300,000 mortgage, and you have £20,000 in savings in the current account, then you will pay interest repayments on £280,000 of the mortgage.
Additionally, this type of mortgage still allows you to withdraw when required.
As house prices continue to rise throughout the United Kingdom, there are new novel products and mortgage innovations which are helping those even with the smallest amount of savings for a deposit to get onto the property ladder.
One such mortgage is the “joint mortgage”, which states that two or more people can take out the loan for a property, but this comes with the caveat that both, and individually are responsible for the repayment of the loan in its entirety.
If one person decides goes bankrupt, the other will be responsible for all of the debt.
If you are not able to take out a mortgage which covers the price in addition to the deposit saved, then a guarantor mortgage is a potential option.
This mortgage assumes that the guarantor can pay the mortgage repayments if you are unable to; however being able to find someone who can take this liability is going to be difficult.
Finally, the help to buy scheme (while not entirely a mortgage product) offers a first time home buyer loan, giving the buyer the opportunity to own a new build home up to £600,000 in value with as little as a £30,000 deposit. Unfortunately, there is no help to buy for older properties.
The Government makes this possible by offering a 20% help to buy loan, which when in addition to the 5% deposit, means that you only need to take out a 75% mortgage.
Furthermore, for existing homes, the government will guarantee up to 15% of a mortgage taken out with a 5% deposit. This means that you must assume a 95% mortgage, but with up to 15% of the value of the home backed by the Government.
When looking to sell from both of these options, the Government will expect their loan back, plus any proportionate amount of the capital gain.
Be aware though, that after five years of using the help to buy loan, that interest rates will need to be paid monthly, so you may decide to either refinance using the built up equity, or to sell completely and buy a new home outright.
With talks of a real estate bubble, it may be holding off on purchasing a house in the meantime, as taking out a house which loses 30% of its value when you put down a 15% deposit, will wipe out your cash equity, and put you in negative equity (where you owe more in repayments that the value of the property).
You must ensure that you have compared all potential options when considering taking out this huge loan.
