The mortgage dilemma – should you fix or go variable?
Securing a housing loan can be a stressful process. Rob Griffin looks at the different factors buyers need to consider before taking the plunge
Saturday 07 May 2011
Arranging a mortgage is not straightforward. Not only is it harder convincing lenders to part with their money these days, but you also have to be on your guard against an array of questionable charges that can be found buried away in the small print. Whether you are a first-time buyer or planning to remortgage, you need to accept that even in the very best case scenarios the process may drag on for a number of weeks and leave you feeling drained of life and seriously out of pocket.
You will also face the choice of navigating your own way through piles of information concerning rates, fees and various conditions, or handing over responsibility to a specialist mortgage broker in the hope they can get you a better deal.
So where should you start – and what do you need to know?
The mortgage market
Let's start with the mortgage market itself. Well, the situation has certainly improved over the past few months but we are still way off the heady days of 2007, according to David Hollingworth, head of communications at London & Country Mortgages.
"There is still quite limited availability of funding but although the amount of deposit you can raise is crucial the deals are generally getting better," he says. "There are even deals for LTV values of up to 90 per cent which is an encouraging sign."
Gross mortgage lending was an estimated £11.3bn in March, which represented a 21 per cent increase on the £9.3bn of the previous month but a two per cent decline on the £11.5bn recorded in March 2010, according to data published by the Council of Mortgage Lenders.
It means gross lending for the first quarter of 2011 was around £30.1bn, an 11 per cent decline from the £33.9bn level in the fourth quarter of last year, but a modest one per cent up on the £29.7bn achieved during the first three months of 2010.
Bob Pannell, chief economist at the CML, attributes the fall in demand for house purchase loans since the start of the year to the fact that household finances are under a lot of pressure, but says demand for remortgaging remains firm. "Remortgage approvals in February were the highest for more than two years and stronger remortgage activity looks set to continue propping up overall lending," he adds.
Interest-only or capital & interest
There are so many questions to answer it can feel like a preliminary round of Mastermind. What kind of product do you want? How much do you need to borrow? Can you raise a decent deposit? Over what term do you want to take the mortgage out?
Arguably the most important decision is choosing between the two main types of mortgage: interest-only and capital and interest.
Interest-only mortgages – as the name suggests – means repayments will only cover the interest being charged on the "loan" taken out. The actual sum borrowed remains the same and a separate investment vehicle has to be built up to pay it off.
In contrast, capital and interest mortgages mean higher monthly repayments, but at least you're paying off the overall debt as well. Every time a payment goes out of your account you will know you are reducing the entire amount owed as well.
Up until the 1980s, most mortgages were capital and interest products, but this reversed over the following decade. Borrowers are now split between the two sides and a decision on what's best for you will depend on your personal circumstances.
Then you need to choose between fixed and variable rate mortgages. Fixed or variable rate? Fixed mortgages can make sense for first-time buyers and those that like to know exactly how much they will be paying out each month so they can budget accordingly. It also protects them against future interest rate rises.
Rates on trackers are often more attractive than fixed-rate products because you're agreeing to take on a higher degree of uncertainty. They suit those who believe interest rates are likely to go down in the future, as well as mature couples who are no longer restricted by tight budgets.
There are pros and cons with each approach. If interest rates fall after you've taken the mortgage out you'll be financially better-off on a tracker. If they rise, meanwhile, you could end up paying out substantially more each month.
So which makes sense in the current environment? Ray Boulger, senior technical manager at John Charcol, believes we may not see interest rate rises in the UK until next year which means tracker products look more attractive.
"If you are making a judgement based on what is going to be the best route to go down then I would say it's too early to go for a fixed-rate product at the moment," he says.
However, fixed-rate products shouldn't be totally ignored as it all depends on what you want from a particular mortgage product, points out Mr Hollingworth at London & Country Mortgages. "Borrowers must remain focused on their own position and what they feel suits them best," he explains. "A proportion of people will always go for that peace of mind."
Such individuals should even consider longer-term fixed rate deals – in the three to five-year spectrum, he suggests. "This might give them a bit more medium term security over a longer period rather than being locked into something for the short-term during which time the Bank of England base rate looks likely to remain pretty low."
Fees and charges
Always be on your guard against fees. Lenders may be offering attractive headline rates but they're also coming up with increasingly innovative ways to claw their money back so you need to analyse exactly how much the mortgage will cost before making a final decision.
The most significant expense will be arrangement fees which have been spiralling upwards in recent years. The cheapest you'll probably find is around the £500 mark, while it's not uncommon to be charged a whopping £2,500 in exchange for an attractive rate.
Sometimes you can be charged a comparatively low arrangement fee but find there is an additional booking fee as well, which other lenders bundle into one – albeit apparently higher – price, points out Michael Ossei, lending expert at uSwitch.com. "Some lenders have scrapped all such booking and administration fees but these will be included in the overall cost of the product," he adds. "Borrowers need to consider the propositions carefully."
Other charges to take into account when deciding whether an offer is financially attractive include legal costs, early repayment charges, higher lending and other assorted "set-up" fees.
There are also fees during the setting up process itself. It is commonplace for lenders to automatically charge you for carrying out a revaluation of your property unless you accept their mortgage offer within an agreed period of time. Similarly, there will be other completion deadlines imposed which could result in a penalty of some description.
The capacity to make overpayments can be very beneficial as these can substantially reduce both the length of your mortgage and the costs involved, but this can also throw up some potentially nasty charges, warns Mr Ossei at uSwitch.com.
"People can get caught out over how much they can overpay in a year," he explains. "Every mortgage provider has a different percentage as far as this overpayment is concerned so borrowers need to ensure they don't exceed this figure or they may be penalised."
An exit fee is often charged by lenders when you redeem your mortgage, either because you have finished paying it off or because you want to switch to another lender. The costs of these have more than quadrupled over the past decade. In 1996, the average exit fee was around £50 and today, now it is approaching the £300 mark, although some lenders charge nothing.
Other administration fees include the telegraphic transfer of funds. This will vary between lenders but is usually around the £35 mark.
Separately, if you go through a mortgage broker, for instance, find out how they get paid. Some will charge you directly, others will be paid by lenders and some are happy to take money from both.
The key is not to get blinded by a great headline rate because once you factor in all the various charges you may find they erode the savings you are hoping to make. Only by crunching the numbers can you be sure of having a good deal.
Regardless of what your personal situation, therefore, there are all manner of questions to be answered during this process and the fact is, whichever route you choose, sorting out your mortgage is unlikely to be completely stress-free.
To be successful you will need to set aside plenty of free time – consider booking a week off work; do your research, have a capacity to analyse figures that would make most accountants baulk; possess bags of determination and have a sense of humour.
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