Personal finance: Making a mortgage a flexible friend

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The Independent Online
No-penalty early repayment, big savings on interest paid, drawdown facilities in an emergency - a new generation of flexible mortgages offers to do things that traditional home loans cannot. Iain Morse looks behind these claims and tries to decide just how different these loans are to the old-style ones.

Barely a day passes without a lender announcing that it has decided to join the flexible loan bandwagon. This new-found love affair with the term "flexibility" is part of a belated recognition by home loan companies that today's borrowers are unlikely to remain in the same jobs for 25 years, with their earnings rising incrementally each year until retirement.

The real question is: just how flexible are such packages? And is it really possible, as many of them are claiming, to save money compared with more traditional mortgages?

One place to start is with the amount you can borrow. Traditional "interest only" and "repayment" loans lend up to a maximum percentage of the value of the property being purchased. This loan to value (LTV) can go as high as 100 per cent for first-time buyers, with most lenders offering 95 per cent as a maximum.

Most flexible loans set this LTV far lower, at 80 per cent of value. According to Ian Darby, marketing director at mortgage broker John Charcol: "This tends to filter out first-time buyers and the less well off. These loans are intended for older professionals, established in careers, with high earnings, and perhaps looking to remortgage."

Flexible loans account for only an estimated 5 per cent of all mortgages taken, offering few discounts or fixed-rate deals. Yet, as Mr Darby points out: "Discounts and cashbacks can account for up to 6 per cent of the value of a conventional mortgage. This is hard to beat."

If there is money to be saved with a flexible loan, it depends on the use borrowers make of any early repayment options, and the basis on which these accounts calculate interest saved by early repayment.

According to Stephanie Jaguer, at Mortgage Express, one flexible loan provider: "Anyone with money to deposit, paying tax on the interest earned, should use their cash to reduce their borrowing. You pay no tax on the interest saved."

It is this "saving" - through the untaxed interest that is no longer paid on the amount of repaid loan - that makes flexible loans good value.

Even a basic-rate taxpayer with money on deposit will be hard put to find net returns better than 3 or 4 per cent. With an average variable mortgage rate at 8.48 per cent, using a cash deposit of pounds 10,000 to reduce borrowing will leave you between pounds 400 to pounds 500 better off.

Figures by UCB Home Loans show that on a loan of pounds 50,000, with flat rate interest of 8.69 per cent calculated daily, repayment of interest and capital over 25 years will cost a total of pounds 122,590. Repayment over 15 years will cost just pounds 89,470, a saving of pounds 33,111. So there are good reasons for making early repayment a priority.

Most traditional mortgages allow early repayment of some or all of the amount owing, but many ask for minimum amounts of pounds 1,000 or more. Mortgage Express will accept far lower minimum repayments of just pounds 25 with their flexible mortgage, with other lenders imposing minimums of pounds 500, and only a minority going up to pounds 1,000.

Early repayment can save you money, but what about the basis on which interest is charged? Most flexible loans levy the lenders' full standard variable rate of interest, but charge interest on your outstanding balance daily or monthly. Much is made of savings from this by comparison to accounts where interest is charged on an annual basis.

On the same terms as above, UCB Home Loans calculates the saving on daily against annually calculated interest over a 25-year term as just pounds 1,485. This becomes more important if during the year borrowers make lump-sum repayments to reduce their mortgage debt. On the annually charged basis, interest payments will not be reduced until the end of the lenders' accounting year, but on a daily basis, there will be an immediate reduction.

Using your cash to reduce mortgage borrowing sounds fine in principle, but may leave you strapped for cash in practice. Most new flexible mortgages will let you borrow money back - this is known as "drawdown" - at standard variable rates.

Virgin's One account offers this facility, and its marketing director Martin Campbell explains its appeal: "Our standard variable rate is cheaper than other sources of consumer credit, and the account will represent a real saving for those using personal loans, conventional overdrafts, and credit cards."

This is certainly true, but one criticism of "drawdown" is that some borrowers will defer paying off their mortgages, and instead use their homes as a source of consumer credit.