Mortgage special: cutting through the complexity
Are we heading for a crash? If we stretch ourselves now, will we reap rewards later? And do first-time buyers stand a chance? The world of home finance can be complex and confusing. Stephen Pritchard has straight answers to the big questions
Wednesday 08 August 2007
'I want to buy the very best house I can afford before house prices rocket out of reach. How far should I push it, and should I switch to an interest-only mortgage so I can borrow more?'
Q. Is this risky?
A. Yes, but it is a risk more people are forced to take. In 1996, first-time buyers' mortgage payments were 10.8 per cent of their salaries. Today that figure is 19.1 per cent.
More homeowners are switching to interest-only mortgages to boost their buying power. A quarter of all homeowners now have interest-only loans and no endowment or other plan to eventually pay off the debt, according to the Council of Mortgage Lenders (CML).
The risk, according to Moneyfacts' Andrew Haggar, is that you become used to the lower monthly payments and fail to set aside any money to pay off the capital. Worse still, if property prices fall and you have not paid back any capital, you will be in negative equity. This could make it very hard to move house.
Q. If I opt for interest-only, how can I pay back the loan amount?
A. The simplest option is to make overpayments on your mortgage with cash. Most lenders allow repayments of up to 10 per cent of the loan each year. Someone overpaying the full 10 per cent each year would actually clear their loan more quickly than through a standard repayment mortgage.
Proceeds from selling shares, cashing in savings, or receiving a lump sum from a pension could work. So might an inheritance. But most people switch to repayment mortgages after a few years, as their incomes rise.
Q. Should I stretch myself to buy the best house I can afford?
A. The cost of moving house, including fees and stamp duty, has risen significantly in the last few years. If you find the "forever house" you really want, and are confident you will stay there, it might be worth the stretch in the short term.
'I'm part of a generation of young people who have fairly well-paid jobs but are stuck in the trap of renting with friends. Is there anything we can do to get on the ladder?'
The average house now costs just a shade under £199,000, according to the Halifax, and the average first-time buyer now borrows £117,000. Since most lenders won't lend a first-time buyer more than four times his or her salary, you would need to be earning almost £30,000 to make this work. These are just average figures – in some parts of the country, the situation is much worse. But there are some innovative ways to get on to the housing ladder.
Buy with friends
If you are already renting with a group of like-minded people, then buying with them might be an option. Lenders usually treat two friends buying together in the same way as a couple. It is harder for larger groups, with fewer lenders offering mortgages. Among those that do are HSBC and Cheltenham & Gloucester.
But even best friends can fall out. "For your own protection it is vital that you put together a legal agreement first that outlines who is liable for what if one of you loses your job or has to move out," says Katie Tucker, technical specialist at mortgage brokers John Charcol. You should also agree how you will split the proceeds when the time comes to sell.
In some parts of Eastern Europe, good properties cost less than £50,000 but prices are rising rapidly. Some canny first-time buyers are playing this to their advantage, using the gains overseas to fund a home here.
There are risks: a foreign market might crash, just as prices rise here. Also, the local currency could fall against sterling and dent the value of your home. You need to be sure the property will sell, and remember that the Inland Revenue will want 40 per cent of your profits as Capital Gains Tax.
Buy to let
If you are priced out of the area you live in, but can afford to buy elsewhere in the UK, you could invest in a buy-to-let property. As long as the rent covers the mortgage, any increase in the property's value will be profit.
You need to pick the right area: the rental markets in several affordable towns are already saturated. And buy-to-let is not ideal if you are looking for short-term profits.
"If you're buying somewhere to let out, you should see it as a medium- to long-term investment. Nor will all lenders lend to first-time buyers," says James Cotton, mortgage adviser at brokers London & Country.
Bank of Mum and Dad
Generous parents could remortgage their own property and give a lump sum to their kids as a deposit. But they would have no claim on the property, should things go wrong.
An alternative is a formal loan, perhaps in return for a share of the profit when the house is sold. Or the parents could charge interest, but write the interest off every year as a gift. With the right paperwork, such gifts are exempt from inheritance tax.
Parents who can't part with the cash can still help out by acting as guarantors. Here, the parent agrees to pay the mortgage for their son or daughter if they fall behind.
Other schemes, such as Bristol and West's First Start, put both parent and child on the mortgage. If the parents' income, after their own mortgage is paid, covers the loan, their offspring's salary won't matter.
If you qualify – and this will depend on where you live and your occupation – shared ownership through a housing association or the Government's HomeBuy scheme is worth considering. You buy part of the house, with the Housing Association owning the rest, in return for rent. You can then buy additional shares, as your income allows.
See the DirectGov website (http://www.direct.gov.uk) for details of available schemes
Lauren Dooley, 29, is a town planner. She has a one-bedroom shared-ownership flat in Vauxhall, south-west London, with her partner Alun.
"When we were first looking to buy, we quickly realised that we wouldn't be able to afford anything in a nice area on the open market. We bought half of our flat last year and we're now in the process of staircasing up to 100 per cent of ownership. I found that there was lots of information out there on shared ownership and lots of lenders offering mortgages specifically for shared-ownership purchases. We sorted out the mortgage and purchase of the flat with the help of Notting Hill Home Ownership, the housing association, and I found the whole process surprisingly easy. We started out on a variable rate, but after all the interest-rate rises, we've now switched to a fixed rate. We don't want our repayments increasing any more."
Lynzi Ashworth, 23, is a communications account executive from Guildford, Surrey. She wants to buy her first home.
"At the moment, I'm dividing my time between living in my partner Rob's rented place and my mum's house, while Rob and I look for somewhere to buy. We'd ideally like to buy a house with its own garden, but it's more likely that we'll only be able to afford a flat with a communal garden. I've found that the whole process of finding a mortgage and a property is really daunting, with there being so much media speculation about rising house prices and the prospect of a property price crash. The information you need about mortgages is out there, you just need to look for it. I've been getting some advice from an independent financial adviser to help us find the best mortgage. I think that I'll be going for a fixed rate as I've heard these are the best type for first-time buyers."
'Should I pay to use a mortgage broker, or should I hunt down the best deal myself on the internet?'
A. There are so many mortgages on offer that it's virtually impossible for any one person to research them all. This has become a lot easier in the past few years thanks to comparison websites such as moneysupermarket.com, but there are two important differences between such websites and a broker.
Websites can compare the mortgages that are generally available. They offer a good service that may show you an attractive offer from a lender you wouldn't have otherwise come across – but they won't be bringing you exclusive deals negotiated directly with a bank or building society.
Neither will the website help you to actually get the mortgage – they just let you know where the offers are and then leave you to it. A good broker can find you deals you would not be able to get elsewhere, and handle the whole application for you.
It can also be soul destroying, not to mention damaging for your credit record, if your application is declined. If you have special circumstances, from old debts to an unusual home, a broker will look for a lender who will consider it when a high-street bank might not.
Q. Should I pay a fee?
A. Even if you don't use a broker, you will still face paying a booking fee. On top of these, brokers can charge a commission or occasionally a flat fee for their time.
Some brokers do not charge a broker's fee. Others will reduce or even waive the fee if you take insurance or other services from them. In any case, the broker will be paid by the lender for giving them your business.
Whether it is worth paying a fee depends on cost, and convenience. If you are too busy to hunt around for a mortgage, or if the broker can find a deal significantly below high street rates, a fee can be worth it.
Even if you go through a broker, you may as well spend 20 minutes online finding what you can get that way. At least then you can see if it's worth paying the broker their fee.
Q. Are there any essential dos and don'ts?
A. Don't pay a mortgage broker anything up front: the fee should only be charged on completion, unless you are paying a specialist financial adviser by the hour.
Check the broker's independence: some deal with hundreds of lenders, others just half a dozen. Compare the quotes they offer with what you can find online.
And remember that whatever an estate agent might say, you are never obliged to speak to their in-house financial adviser.
Joanne Johnson, 43, is a pharmacy assistant and lone parent of two teenagers. She lives in a three-bedroom semi-detached house in Southport, Merseyside.
"I went to my bank for a mortgage. I know it probably isn't offering me the best deal, but I can't be bothered looking around – I just want someone to tell me, 'Here's your mortgage sorted, and here's how much it's going to cost you.' I don't especially understand all the lingo around mortgages; I think it can be very confusing for a lot of people. I think I'm on a fixed deal at the moment and I've got 15 years left to pay on it. I probably won't go to another lender when this deal finishes. I know this might be a bit naive, but I just don't have the time to shop around and find another lender. "
'I'm planning to move soon – should I sell my current home or rent it out?'
A. This is sometimes called "let to buy". Whether it's worth doing depends on whether your existing property is a good rental bet. Ask three local estate agents for a rental valuation, and ask them how easy it is to let such a property. Tenants don't always want the same thing as buyers. If you live in a terrace, for instance, you might find that you can make more by selling. If you live in a flat, renting it out might well be better than selling it.
Q. Can I still borrow as much to buy my new home?
A. No – you'll probably only be able to borrow up to 85 per cent of your current home's value, so you won't free up all the money, as you would if you just sell up. Think of it in terms of needing a deposit on the buy-to-let.
You'll also need to budget to pay the mortgage, service charges and possibly bills if the property is empty, so you'll need to leave yourself a little breathing space.
Q. Will the rent cover the new mortgage?
A. This depends on the property, location and your deposit. For the best buy-to-let mortgages (the ones that don't require you to payhigh fees up front) you will need a rental income that is 15 per cent or more above mortgage costs.
When it comes to working out your profits, you will of course have to pay income tax, but remember that you can deduct your mortgage interest payments, agency fees and other costs against your profits.
Rising house prices have made it harder for many landlords to make big money. But remember that if property prices rise, you'll be making more money as equity than you would if you only owned one place – simply because you own more bricks and mortar.
Letting to buy might well work if you are moving to a cheaper area and so have some spare cash, or think that you could need to move back to the property at some point.
'I'm buying a villa abroad. Should I remortgage my home, get a new mortgage through a UK bank, or borrow overseas?'
"The easiest way of raising money to buy abroad is to release equity from your UK home," says Melanie Bien, director at mortgage broker Savills Private Finance. Remortgaging in the UK is easy, as long as you have equity in your home. Most lenders will not ask why you are borrowing the money, and your mortgage payments will be in sterling, so you'll be safe from currency fluctuations. Nor will you need a valuation on the second home. But you can't usually offset mortgage interest against rental profits from the foreign property this way, so it may not be the most tax-efficient approach if you plan to rent out the property in question.
What if I can't remortgage my home?
In some respects, getting a new, separate mortgage keeps things simple, and should also let you deduct the payments from your rental income, lowering your income tax bill. Many UK firms will not lend on overseas property, but it depends where you're buying. Norwich and Peterborough, for example, lend in sterling on properties in Spain. So will overseas branches of some UK banks.
The other option is to borrow the money in the local currency where you are buying. This can be the best option, especially if you have local-currency income from the rent. It can also simplify tax. Plus, overseas interest rates are often lower than in the UK.
Property, tax, inheritance and planning laws can be complex overseas. So arranging a foreign-currency mortgage through a UK bank – Barclays and Lloyds TSB both offer this – or a specialised broker, such as Savills or Conti, gives you peace of mind as well as valuable local knowledge.
'I'm fed up of paying fees every time I move my mortgage. Should I stick to the same deal for the long term, or continue to change every two to five years?'
A. With some mortgage arrangement fees at £1,500 or more, plus valuation, legal and exit charges, this is a valid question. Switching lenders every two years or so can quickly cost more than the interest you will save, unless you have a large mortgage.
Q. What are my options?
A. You could opt for a long-term, fee-free mortgage deal. Woolwich's lifetime tracker has set the lead, and currently charges 5.92 per cent. This is not the cheapest mortgage out there but there are no fees or penalties, so you can move to another loan if you want to.
For total peace of mind, you could consider a long-term, fixed-rate mortgage. Halifax has just launched a 25-year fixed-rate deal. There are no ties after 10 years and the mortgage has some flexible features. But at 6.39 per cent, you are paying a premium for security.
Q. Is a high fee always bad?
A. No – a high fee can save money. "As a general rule, the bigger the mortgage, the more important the rate and the less important the fee. Work out the total cost of the mortgage – rate plus fees – when comparing deals to find the right one," says Melanie Bien, director at Savills Private Finance.
If it is a two-year deal, add all the fees and two years' interest together to work out the total cost. If it is a five-year deal, spread the fees over five years, and so on.
Watch out, though, for percentage fees. These rise in line with the amount you borrow, so are only worthwhile if the interest rate is very keen. Also be very cautious about any mortgage which ties you in with penalties after the fixed or discount rate ends. Few brokers recommend these, except in special circumstances.
Bob Finch, 53, is an area manager for Shelter. He lives with his wife, Julia, in a three-bedroom house in South Shields. They have two adult children.
"We've only got eight years left on our mortgage. We were on a capped deal for five years, but recently we've been on the building society's variable rate. Every time we've asked our mortgage advisers about moving, they've told us it's not worth it because of the fees. Young people are facing a very tough time. Rent is cheaper than a mortgage in our area, but it isn't secure enough to bring up a family so they're borrowing big mortgages that some of them will struggle to keep up with."
'I need to remortgage soon. I usually have a clear idea about whether to get a variable or fixed rate, but it all seems so complicated at the moment and I've no idea what to do'
The case for fixed mortgages
Homeowners breathed a sigh of relief last week when the Bank of England decided to keep interest rates on hold. Still, many leading analysts expect further rises. Even if you're in the middle of a fixed-rate mortgage, you're not immune from the rates rises – according to the Council of Mortgage lenders, more than two million borrowers will come off a fixed-rate mortgage in the next year and a half, and most of these will face rises of between 0.75 and 1.5 per cent.
The problem is that fixed rates – and five-year fixed rates especially – look poor value right now. "A five-year fixed rate will protect you from rate rises and are good – if you think you would struggle if interest rates will go up twice more," says Katie Tucker, technical specialist at mortgage brokers John Charcol. "I say twice because they are priced a little higher than tracker and discount rates to start with so you have to factor this in."
The best five-year fixed rates are just shy of 6 per cent, such as Cheshire BS's 5.94 per cent with an arrangement fee of £1,499. Nor will you save much by opting for a two-year fixed rate: according to Moneyfacts, the best deal right now is again at the Cheshire, at 5.69 per cent with a fee of £899. But for anyone worried because they're stretching themselves now a fixed rate is the way to go.
The case for variable rates
Trackers and discount rates are cheaper than fixed-rate mortgages. These deals could be a good option for a buyer who has enough slack in their budget to cope with base rates rising a few more times.
At John Charcol, Tucker suggests Saffron, which has a discount mortgage at 5.45 per cent, with no penalties. The arrangement fee of £899 is not as onerous as some, and it's possible to switch to a fixed rate once these start to look more attractive.
The way the economy is at the moment, no one is really sure whether rates will keep rising, plateau or start falling in a year or so, and some will doubtless be attracted by the idea of keeping their options open. But borrowers need to keep in mind the cost of switching mortgages, if they decide that they want a fixed rate after all.
Lynda Bunn, 58, is a charity liaison officer from Wolverhampton. She lives in a three-bedroom semi-detached house with her husband David. They have two grown-up children.
"We're on the homeward strait now with our mortgage. Looking back, I think we wish we'd borrowed a bit more and pushed ourselves further, though I'm not sure whether borrowing more is always good advice for young buyers today. We're on a discounted variable-rate mortgage. I think it would be great for young people to have the sorts of deals that last many years – it would be lovely for them to have the security. If I had any advice for younger borrowers it would be always to see what other deals are available when they come to the end of any special rate. Lots of people didn't when we first got a mortgage – you just stuck with whatever rate you were given. But these days, it's really important to shop around."
'We're retiring a little early, and while we don't want to blow our children's inheritance, we like the idea of freeing up some money from our house. What's the best way to go about it?'
A. Research by the Prudential found that last year, 13 million people planned to put money from their property towards their retirement.
If you need a lump sum, and you can cover mortgage payments from your pension, remortgaging is the simple option. You should be able to find a mortgage on a lender's standard terms, and you keep complete ownership of the house.
Otherwise, there are equity release schemes. These come in two types. Home reversion plans let you stay in your home, but you sell all or part of it to a company in return for regular cash or a lump sum. The other type is lifetime mortgages. These let you keep the property and raise money without paying monthly bills – the interest "rolls up" so you only pay it off when you sell the house (or die).
In either case you will eat into your inheritance, because the provider will need to make a profit on the deal. Usually, equity release plans are limited to 30 to 40 per cent of the value of your home, depending on your age.
But there's a simpler idea – don't discount selling up to buy somewhere cheaper. It might be a wrench at first but you will pay no interest. A smaller house will also be cheaper to run, and more manageable too.
See the Financial Services Authority's website for further information (http://tinyurl.com/2czkrn)
Mark Picken, 32, is managing director of a marketing company in Falmouth, Cornwall. He lives a in a two-bedroom penthouse flat with fiancée, Rachel, who is 25.
"This is the second property I've owned. It was originally going to be my parents' retirement home, but they very kindly offered to sell it to me. I'm buying the place with the help of a lump sum I inherited after my grandmother passed away. As soon as the money cleared, my bank was on the phone, a bit like vultures, so I didn't go with them for my mortgage. I sought independent financial advice and I think I got the best deal I could. We've gone for a tracker mortgage because interest rates would have to rise twice to be the same price as a fixed deal, and this way if rates fall I can reap the benefits."
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