Tony Lyons explains how to pick the right type
The house buying season is currently in full swing. Estate agents throughout the country are seeing plenty of customers wanting to buy a new home. And mortgage lenders have plenty of money which they are eager to lend.
Buying a house is probably the largest single purchase any of us ever makes but it can be a stressful and expensive business. Not only do you have to deal with smooth-talking estate agents, you will also probably need a solicitor and then, unless you have a pile of cash, you need to arrange a mortgage.
Once upon a time, the choice of mortgage was easy. There was the conventional repayment loan or an endowment mortgage. Both had variable interest rates, changing as lenders moved their rates up and down with the general economic climate.
Nowadays, it is much more complicated, with many needing to seek advice from either a lender or a mortgage broker. While most will find you a suitable package, in the past you were never sure if you were being sold a mortgage that best suited your wallet or one that earned the provider the highest commission. This was especially true when it came to endowment mortgages.
Now, most leading providers have signed up to a voluntary code of conduct, devised by the Council of Mortgage Lenders, which stipulates that the lender should receive full details of the charges and the reasons why a particular mortgage was recommended. The Government is keeping a watchful eye on how the new code operates but has warned that if it fails to curb any excesses in the market, it will step in with legislation and that mortgage lending will come under the aegis of the Financial Services Authority, the new super regulator.
So, how do you decide on the type of mortgage that best suits you? "The right type of home loan for anyone will depends on their individual circumstances," says Siobhan Hotten, marketing manager of John Charcol, an independent financial adviser and the largest mortgage broker in the UK. "So much will depend on the clients' attitude to risk."
The most favoured means of paying off a mortgage are:
Repayment method: the traditional means of repayment, where every monthly payment goes towards paying off the interest and some of the capital.
"This suits most people, especially if they have a low-risk attitude and are in salaried occupations," Ms Hotten says. However, it is inflexible. Nowadays, we tend to move house every six or seven years. Someone in their late twenties can expect to move five or six times before they retire. But in the early days of a repayment mortgage, only a small amount of capital is repaid. If you move house, you will probably have to take out a new loan, maybe for another 20 or 25 years. This will mean you go on extending the time you will be paying off your borrowings.
Interest-only mortgages: more flexible, as you can transfer the mortgage when you move house. You may have to top up the loan every time you move or take out an additional mortgage and you will have to repay the capital at the end of the period.
Repayment of the sum borrowed is normally done through one or other saving schemes, the most tax efficient of which are:
n With-profits endowments, where you pay premiums into a life assurance plan. Nowadays, the low-cost versions of these plans assume the insurance company will continue to pay at least 80 per cent of the current bonus rate - that is the profit you make on the policy - and forecast growth of 7.5 per cent a year.
"These policies were oversold in the 1980s," comments Ms Hotten, "and have been heavily criticised. They are suitable for those with a low attitude to risk. They offer valuable life cover and are quite often packaged with critical illness cover, protecting you if you are unable to work."
The past criticism was due to the high commission rates paid to advisers, often equal to the first year's premium, and the decline in bonus rates in recent years due to falling inflation and the consequent decline in yields on fixed-interest stocks. But they appear to have stabilised and insurance companies are now more realistic on the growth rates they are forecasting for their life funds.
A 30-year-old non-smoker should expect to pay around pounds 75 a month or less with one of the better insurers for a 25-year, low-cost with-profits endowment of pounds 50,000, or under pounds 80 a month if includes critical illness cover, which pays a lump sum on diagnosis of a life-threatening illness.
n PEP mortgages, where you pay into a personal equity plan (PEP), using the proceeds to pay off the capital whenever you have accumulated enough. Now that we know PEPs have been ring fenced with no lifetime limit, they have come back into popularity.
"This type of repayment suits someone who is aware of the risks involved with equity investment. When Individual Savings Accounts arrive next year," says Ms Hotten, "there is no reason why they could not be used for repaying a mortgage."
n Pension mortgages, where you repay the capital out of the lump sum you are allowed to take out of your pension fund when you retire. Under the rules, up to a quarter of your accumulated pension can taken in cash at retirement.
"These are best suited to the highly paid who have high net worth, as it means that a substantial sum will be paid over to a mortgage lender at a time when most will be looking for ways to maximise their income," Ms Hotten warns.
There are any number of inducements being offered to mortgage borrowers these days. Cash backs, discounts and fixed-rate home loans are very popular, but do watch out for penalties. In addition, some of the newer entrants into the mortgage market, including Virgin and Kleinwort Benson, are offering flexible lending packages. These are modern "lifestyle accounts" where, as long as you stay within their rules, your home loan is treated as just part of your overall borrowing and you can pay as little or as much as you can afford so long as mortgage is paid off in due course.
"Whatever you do, make sure you shop around for the home loan that meets your needs and at a price you can afford," Ms Hotten says. "If you find it confusing or too complex, go and see a truly professional adviser".Reuse content