To buy, or not to buy

Financial Makeover NAME STEVE CLARKE AGE 24 OCCUPATION TENANCY SUPPORT WORKER
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The Independent Online
Steve works for a major alcohol charity, helping its clients in their own homes. He earns pounds 19,000 a year and has about pounds 1,000 in savings. However, he also owes money to the Student Loans Company - a relic of his student days, plus to his bank. He is in a contributory pension scheme.

Although Steve rents his accommodation, he also has his eyes on a two- bedroomed property, for which his bid of pounds 44,000 was recently accepted. Steve, who is single, also intends to travel in a year's time and is thinking of renting out his property. Steve feels he needs independent financial advice if only "to ease my financial angst, never mind bank account".

The adviser: Tyrone Silcott, independent financial adviser at City Independent Financial Planning, 3 Tolpuddle Street, London, N1 0XT (0171 837 3133).

The advice: If I were advising Steve before he had found this particular property, I would tell him to get some money behind him first.

Unlike most people in London, Steve's current rent is significantly lower than a new mortgage will be. Therefore he should take this opportunity to build a sizeable nest egg and get rid of any small debts. It is also unlikely that property prices will rise a great deal over the next 12 months, while interest rates may well be lower than they are today.

The problem with buying a property without having at least 5 to 10 per cent of the purchase price (5 per cent at least for the deposit, plus an amount for the associated costs), is that his choice of lender is restricted, and because of the limited choice any mortgage he obtains may not be exactly what he wants.

However, Steve has found a property that he considers to be too good an opportunity to let pass. It is within his price range, gives him all the room he needs, and he believes is particularly good value. Even though I would prefer him to wait, he is determined to go ahead so let's look at the type of loan he needs.

Normally I would avoid any lender that imposed redemption penalties in the first few years of the mortgage but he needs cash now. This would lead me reluctantly to look at a cash-back mortgage, where lenders offer a percentage of any loan in cash to the borrower as an incentive to take out their loan.

As a first time buyer Steve would also like to control his potential mortgage payments in the first four or five years. The most popular way of achieving this is via a fixed rate or capped rate.

Woolwich is offering a four-year fixed rate at 6.79 per cent, plus a cash-back of 3 per cent. The problem with fixed rates, though, is that if interest rates fall Steve may find himself paying more than he needs to.

I prefer capped rates, as they protect against any increase in rates and also allow the client to benefit from any decreases. It is possible to get a capped rate of 7.99 per cent for five years with the Bank of Ireland, with a 4 per cent cashback.

Both mortgages have redemption penalties. The Woolwich scheme has a penalty of 6 per cent of the amount redeemed in the first three years and 3 per cent for the next three years.

My preference for clients who are likely to move several times and who know they are likely to move within six years is for an interest-only mortgage rather than a repayment one.

Sometimes, in the first years of a repayment mortgage little capital is paid, so each time you move not as much capital as you would hope will have been eaten into.

In an interest-only mortgage the client is allowed to build the capital independently via a number of investment choices including PEPs, the new Individual Saving Account, endowments, or unit trusts. Other options include pension-linked mortgages, which I would not recommend for Steve.

Certainly the combination of PEPS, until April 1999, and ISAs thereafter affords the most flexibility and the most tax efficiency. Endowments are not as flexible or tax efficient. However they can be cost-effective if you add in life cover and critical illness cover.

This last point is important. When taking on a mortgage, individuals should not only plan for everything going well - they must also plan for events that go against them.

As a single person, life insurance is not normally recommended. However, the lender will normally require that he have it. We would strongly recommend that he add critical illness into the portfolio, so that in the event of serious illness a lump sum is paid at least equal to his mortgage debt.

If Steve decides to go the endowment route he should certainly look at a provider that does not have front-loaded charges so that if he needs to cash it in early, he won't lose most of the value in up front charges. Suitable providers include Standard Life and Scottish Widows.

Because Steve has no emergency cash, he will be unable to meet his payments if he is unable to work due to long term illness or redundancy. His work is stressful and can lead to a long-term lay off. His employer guarantees full pay for six months, followed by half-pay for a further six months. I would recommend that Steve purchases permanent health insurance (PHI) to provide him with a monthly income if he is unable to work due to illness or injury.

The policy should start paying half pay after six months illness and full pay after 12 months. For a young person the cost of such a benefit will be relatively low.

Once Steve has moved into the property he should then focus on short- term savings. His goal is to accumulate the equivalent of three months' income in a savings account. A high interest postal or telephone account that affords instant access is most suitable. Again, Standard Life or one of the new supermarket banks, all paying above 7 per cent gross would be suitable.

After six months he should sit down with me again and evaluate how easy or difficult it has been to meet his payments. We can then look at ways of paying off his small loans quickly and to look at his medium to long term savings.

As he has been in an occupational pension scheme from an extremely young age retirement is not currently a priority.

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