Mortgages - the Basics

The credit crunch has hit the mortgage market hard - the number of mortgage products available has fallen sharply and lenders are imposing much stricter lending criteria. However most of us will have to take on a mortgage at some time to finance a property purchase so here are the basics to get you started. A mortgage is simply a loan you take out to purchase a home. Your mortgage is a secured loan. In effect you are borrowing money directly against the value of your house or property. This guide explains how big a mortgage you may borrow what your mortgage will cost and some of the ways you may pay your mortgage back.

Why do I need a mortgage?

The most money you are ever likely to spend in one go will be on a pile of bricks and mortar. Few of us are independently wealthy and that means that most of us take out a loan.

The standard variable mortgage rate SVR over the first seven years of the new millennium has averaged 5.42 but from early 2007 as the effects of the US sub prime debt crisis began to be felt in the UK the mortgage market here began to contract and many SVRs now stand at or around the 7 mark Back in the 1950's the average SVR was 4.99 and there were only six rate changes over the decade. In the 1960's the average rate was 6.75; for the 1970's it was 10.07. By the 1980's the average had risen to 12.83 dropping back to 8.58 in the 1990's Source - Council of Mortgage Lenders June 2008.

Up until November 1984 the Building Societies Association set an official mortgage rate and no matter which institution you borrowed from that would be the rate you would get. A truly free market in mortgage rates only became possible for the first time following the 1986 Building Societies Act.

How much can I borrow?

Whether you are contemplating a first mortgage a remortgage or a new mortgage if you are moving bear in mind that you cannot rely on the lenders themselves to give you "best advice" - your home loan lender is not under any legal obligation to do so.

As a rough rule of thumb you may generally borrow three times the first income plus half of the second income or two-and-a-half times joint income. In the recent past at the height of what many now see as a bubble in the housing market higher income multiples were not uncommon and in some cases lenders were prepared to allow you to borrow four and even five times income this is no longer the case. Do remember that the higher the multiple the greater the burden debt repayments will be and your home may be repossessed if you do not keep up repayments on your mortgage.

Equally you will now be required to find a substantial deposit before a lender will consider advancing you a mortgage. At the height of the housing boom in 2006 you would have found lenders prepared to offer 100 even in some cases up to 125 loan-to-value mortgages. These are no longer available. Even 95 loan-to-value mortgages were fast disappearing in the early months of 2008.

If you do manage to borrow more than 75% of the asking price of the property beware that you may be required to pay a higher lending charge HLC as well. Not all institutions require this and some make a point of not doing so. Bear in mind also that the larger your loan in relation to the value of the property the higher the interest rate you may be asked to pay.

What will it cost me?

In general you will now be expected to have a deposit of around 10% of the asking price of the property you want to buy. Thus if you were looking to purchase an "average" property with an asking price of around £184000 most lenders will expect you to have around £18400 to put down as a deposit.

You will also face a potential plethora of fees and charges not least from your mortgage lender who may charge a variety of set up arrangement and admin fees as part of your mortgage offer. Mortgage arrangement costs have risen sharply with more than a third of fixed rate mortgage deals now charging a fee of £750 or more Source Daily Telegraph 12062008. Indeed some mortgage fees are now based on a percentage of the loan amount and therefore could run to several thousand pounds.

You will have other expenses as well. Solicitors fees valuation arrangement and HLC Higher Lending Charge costs soon mount up. You should allow between 1-3 of the asking price to cover these costs.

Finally, while house sellers face no tax bill providing the property being sold qualifies as your sole or main domestic residence, purchasers may be required to pay Stamp Duty Land Tax. Properties worth less than £125000 attract no duty but over that price it is payable on the full value of the property at a rate of between 1-4 depending on price.

Once you have taken account of all these costs your basic mortgage choices are a variable rate a fixed rate loan or a discounted rate which offers a discount on the variable rate. Some fixed rate loans and discounted offers have a sting in the tail in that you are required to stick with your mortgage lenders variable rate for some years after your initial deal expires. This means you give up the right to shop around for another cheaper deal unless you pay a stiff early repayment charge. Such penalties are designed to tie you to the lender after the cut-price period has ended. If you want to pay off all or part of your mortgage you may face punitive costs which can be as high as six months repayments.

Fixed rate mortgages fix your monthly repayment over a set period of time regardless of what happens to interest rates in the market. After the end of the fixed rate period your mortgage cost will revert to the lenders standard variable rate. Discounted rate mortgages peg the interest rate you are charged to a fixed amount below the variable rate. If the variable rate rises so will yours and likewise if its falls. Thus you are afforded some protection from higher interest rates but are also able to benefit from any cuts in interest rates.

How do I pay back what I've borrowed?

Most mortgage loans are structured to run for a term of 25 years. Your basic choice is between a straightforward repayment mortgage and an interest-only mortgage with some form of investment attached to it with a view to it growing to pay the loan off at the end of the term.

With a repayment mortgage your monthly instalments consist of both capital and interest and hence the balance of the loan will reduce over time. Alternatively with an interest-only mortgage you pay just the interest to the lender during the term leaving the outstanding loan unchanged and you need to make other arrangements to repay the originally borrowed capital. If you want the potential risk and reward of an investment-linked mortgage it makes little sense now to take out an endowment policy. There is no tax relief on the life assurance part of the policy - that was scrapped in 1984 - and the income return on your funds will have been taxed. It may make more sense if you want to tie your mortgage to an investment to consider an alternative investment option. One example could be an Individual Savings Account ISA mortgage. There is more flexibility in an ISA than there is in an endowment policy. While your investments may be affected by market performance and there is no guarantee that they will be sufficient to repay the loan the charges are more transparent than with an endowment policy and ISA plans also benefit from certain tax advantages.

In recent years a new form of mortgage deal has appeared in the market. These so-called flexible mortgages allow you to have one account which combines a home loan and a current account into one. So if you take out say a £75000 mortgage and then you win £10000 on the premium bonds you can simply without penalty reduce the size of your mortgage. Flexible mortgages may come with cheque books attached. So conversely if you suddenly need an extra £5000 youll be able to write a cheque and in the process increase the overall size of your home loan to £80000. Different lenders have different limits for the proportion of your home loan to property value that you may have outstanding at any one time.

2009-03-09 16:34:10 © Moneyextra.com

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