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If you’re taking out a mortgage for the first time, making sense of all the options and costs involved can be difficult. Our guide will help you make the right decisions
With over 6000 different mortgage products on the market at any one time, choosing between them, especially when it’s your first time, can be daunting. The UK mortgage market is one of the most competitive in the world, which is great for consumers but does not make it easy when you’re trying to decide on the best product for your circumstances.
Not only do you have to consider which mortgage type to go for but which lender, rate and payment term. It’s also important to take both upfront and longer-term charges into account, including fees, early repayment charges and extended tie-ins. Taking a systematic approach to the decision-making process and gathering as much information as possible will help.
The most common mortgage types taken out by first-time buyers are fixed and discount. Both have an initial period where the interest rate is fixed or discounted – usually for two, three or five years – after which the rate reverts to the lender’s standard variable rate (SVR). For some products the subsequent rate may be a tracker and follow the Bank of England base rate at a set percentage above it.
With a fixed rate you will know exactly what your repayments will be each month, regardless of what happens to the base rate, while a discounted rate is variable and could go up or down, so you would need to be sure you could cope if your rate went up. Having the peace of mind of a fixed rate often means paying a slightly higher interest rate and higher upfront fees. The interest rate will also not go down if the base rate does, as with a discounted rate.
Whether you should choose a fixed or discounted product depends on your needs and requirements. “If you are looking to save money in the early years a discount or tracker product may be most appropriate,” says Julie Moulsdale of the Royal Bank of Scotland. “Or you may be looking to pay the same amount each month to help you budget, in which case a fixed rate may be more suitable.”
If you decide to take out a fixed rate you should weigh up its higher cost against the benefit of the financial certainty it brings and what you think will happen to rates. “In a low-rate environment, as we have now, you need to question whether you are paying over the odds,” says chief executive of mortgage broker Mortgageforce, Rob Clifford. “There is not really much of a premium on fixed rates now but variable rates can also go down if the base rate does, which is likely to happen in 2006, so don’t automatically go for a fixed rate.”
Generally speaking, the lower the loan-to-value (LTV) you borrow, the lower the interest rate you’ll pay. “Borrow as little as possible and put down as much of a deposit as possible,” advises Rob Clifford. The lower the LTV the less exposed you will also be to negative inflation, which will reduce the equity in your home.
If you are unable to raise a deposit, a 100% mortgage could be a good option and while you could once have expected to pay significantly more than with a lower LTV, rates are now more competitive than ever.
Borrowing 100% can be risky in that if there is negative house price inflation you will go into negative equity more quickly. However, in the current climate of stable house prices this is not likely to happen. “Although house prices may not grow much this year, negative house price inflation is close to impossible, so the chances of falling into negative equity are remote,” says Rob Clifford. “As long as you can afford the repayments, whether you borrow 95%, 100% or 105% doesn’t really matter.”
You shouldn’t just look at the headline rate when deciding on a product but also the fees, charges and long-term costs involved. Fixed-rate mortgages, for example, may incur a booking fee, which you pay to secure the product at a particular rate, as well as the arrangement fee applicable to most mortgages.
If you borrow over 90% LTV, a higher lending charge (HLC) may apply, which protects the lender against you defaulting on your mortgage and offsets the risk involved in lending that much. Some lenders, however, have stopped imposing them, including Cheltenham & Gloucester, Co-operative Bank, Nationwide and Scottish Widows Bank. So far around 30 lenders have abolished HLCs and there are calls for more do so.
It’s also important to consider early repayment charges (ERCs), which apply if you pay off all or part of your mortgage before a particular time. However, few people can actually afford to do this and many mortgages are portable so you can take them with you if you move house. This means ERCs are not always a bad thing as they can give you a lower interest rate.
However, if ERCs continue to apply after the end of an initial deal – known as extended ERCs or tie-ins – you will not be able to remortgage to a better deal after your rate reverts to the SVR without incurring extra costs, which could mean remortgaging is not worthwhile and you will have to continue paying the SVR.
A mortgage with high fees may be less expensive in the long run so you should look at the overall costs of the mortgage, not just the upfront fees, when choosing one. Also watch out for any fees that will be added on completion. “It’s important borrowers assess any mortgage deal in terms of its overall suitability to their circumstances,” says Jaqualyn Purcell of Northern Rock. “Considering fees alone will not provide a true picture.”
By law lenders must display the annual percentage rate (APR) of a mortgage to make products easier to compare. This is designed to show the average cost of borrowing per year for the life of the mortgage, taking into account fees, charges and the higher interest rate paid after the initial deal is over. However, as borrowers keep a product for an average of just four to five years, a figure based on a 25-year term can be misleading.
Being able to afford the mortgage repayments is often one of the biggest problems for first-time buyers. As well as making sure you get the best overall mortgage deal, there are other ways you can make it more affordable, including getting financial help from family, buying with friends or going for shared ownership or a scheme such as Homebuy, where you get government assistance.
One way to boost affordability is to take out an interest-only mortgage. While most borrowers today take out a capital and interest repayment mortgage, some opt to pay only the interest and then take out a repayment vehicle such as an endowment policy or ISA to pay off the capital at the end of the term and possibly make some extra money in the process. However, it is possible to pay just the interest for a while to make your repayments easier.
If you do go for interest-only it’s important to understand what this means and that you will still have to pay off the capital at the end of the term to own your home outright. It also means the only equity you will be building up will be through capital appreciation, which is not occurring much in today’s relatively flat market.
“It’s a bad idea if you don’t do anything about paying off the capital long term and you should review the situation on an annual basis,” says Andrew Frankish, managing director of mortgage broker Mortgage Talk. It’s also not advisable unless you expect your salary to rise significantly in the future and reach a level that allows you to start paying off the capital.
Taking out a mortgage over, say, 30 years instead of the usual 25 is another way to reduce your repayments as they will be spread over a longer period. This is less risky than paying interest only but as you will be paying interest for longer you will pay more in the long run. However, taking out a 30-year mortgage does not necessarily mean you will actually have it for 30 years, as you can readjust your situation in the future.
Being honest about your current and potential future circumstances will help your advisor give you the best advice possible. The high level of competition in the mortgage market means there are often excellent deals around – an advisor can make sure you are in the right place at the right time and that your experiences as a homeowner are as financially stress-free as possible.
Article taken from 'Mortgage Advisor and home buyer magazine' - February 2006