First steps on the property ladder

Repayment or endowment? How much can I borrow? What if I'm ill, or lose my job? How do I find the best deal? Clifford German provides a guide for the home-buyer
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The Independent Online
There was a time when if you wanted a mortgage, you put on your best suit and went to see the manager of the local building society clutching your pass-book, which proved you had been saving for the deposit on the home you wanted. If you were lucky, the manager said yes and you were on your way.

Then came deregulation. The interest-rate cartel disappeared, banks and building societies competed to lend money, we all started paying silly prices for homes, the market collapsed. Now houses again look dirt cheap, mortgages are two a penny, but no one wants to buy a house.

Some things, however, do not change. If you are in regular paid employment, you will still need to earn three times the amount you want to borrow. Overtime, bonuses, earnings from temporary work and a partner's income may be added to your earnings, but only on a single multiple.

Couples may be allowed to combine their incomes, but can only borrow 2.5 times the joint income. Self-employed people usually have to produce accounts for the past three years and show a consistent pattern of income.

If you fail the earnings test, you might find a mortgage broker who can negotiate a deal for you, but it will probably cost more.

If you pass the test, you can choose between a repayment mortgage, an endowment, and a mortgage linked to a Personal Equity Plan or a pension plan.

Equal monthly payments on a repayment mortgage are divided between interest payments, which should fall as the capital reduces, and capital repayments, which gradually accelerate as the interest on the remaining loan declines.

When the balance falls below pounds 30,000, the tax relief on the remaining interest also starts reducing, but after a few years borrowers with repayment mortgages get a comfortable feeling that they have already paid off a lot of debt.

Repayment mortgages have staged a comeback, but just over half of all mortgages are linked to an endowment policy. Under this kind of arrangement the borrower pays the interest on the loan, plus a monthly premium into an endowment policy. The policy is invested to produce a fund that pays off the loan in one fell swoop when the mortgage term falls due, with a sizeable chunk of profit left over!

Endowments are no longer sure-fire winners, because low interest rates and low inflation make it harder for the invested premiums to grow the necessary funds to pay off the mortgage, while the size of the loan remains unchanged throughout the life of the mortgage, leaving borrowers at greater risk of falling into the negative equity trap, where the property value falls below the amount they owe.

Interest rates on outstanding loans are lower than they used to be, but they are higher in relation to inflation, and tax relief on the mortgage interest is worth less than it used to be.

Many lenders also offer pension mortgages, which allow borrowers to pay only the interest on the outstanding loan and contribute the balance of the monthly payments into a pension fund.

Top-rate taxpayers prefer pension mortgages because contributions can be deducted from taxable income, but the lump sum on retirement goes to pay off the mortgage rather than buy a pension.

Alternatively, borrowers can pay interest plus contributions to a succession of Personal Equity Plans. These contributions come out of taxed income, the value of the fund can fall as well as rise, but any income and capital gains are tax-free.

The next decision is how much you need to borrow. Lenders are keen to do business, and if your income is secure you can once again find a lender willing to lend you 100 per cent of the value of the property (always remembering that lenders base their offers on the value that their surveyors place on the property, not on the price you agree to pay for it).

If you borrow more than 75 per cent of the loan to value (LTV), you will be expected to pay for a mortgage guarantee policy. This protects the lender (not the borrower) if you fail to keep up the payments and the property is repossessed.

You might also be advised to take out a mortgage protection policy to pay your mortgage if you lose your job through sickness, accident and/or redundancy. Most policies will pay for up to a year, while you find a new job or sell the property.

Even with a deposit as little 5 to 10 per cent, you should be eligible for a special deal. Anyone with an existing mortgage whose property is worth 10 to 25 per cent more than the mortgage is also eligible to get a special deal by paying off the existing loan and remortgaging with a different lender.

Special deals include fixed-rate mortgages, where the rate is guaranteed not to change for a year, two years, three, five, even 10 years. Alternatively, you can get a rebate or cashback of up to 6 per cent of the value of your mortgage to switch to a new lender, or a discount on the going rate of interest. The best offers are worth up to 6 per cent off for a year, or 3 per cent for two years, or 2 per cent for three years.

To get the best discounts, you may have to insure your house and contents with your lender, whose policies may not be the cheapest on the market. If you take a special deal, you also revert to the lender's standard variable rate once the concession ends. You are also obliged to repay the rebates if you do not stay with the new lender for a minimum of five years (or two years beyond the end of some of the longer deals).

If this does not suit your circumstances, you can probably get up to 1 per cent off standard mortgage mortgage rates indefinitely from one of the new direct lending operations, which cut overheads by lending over the telephone - and still retain your freedom to switch.

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