Trading down without tears

Buying a smaller house should mean saving money - but watch out for mortgage traps, says Stephen Pritchard

The property boom of the past few years means that when homeowners trade down - often to find something more manageable once children have moved out - they will usually have money left over. Often, a couple trading down from a family house to something smaller might be able to avoid a mortgage altogether. But if not, they will need to give careful consideration to the costs of paying off one loan and arranging another. Even where downsizers will have no mortgage at all, they still face costs associated with paying off the original loan. And these costs are on the rise.

The property boom of the past few years means that when homeowners trade down - often to find something more manageable once children have moved out - they will usually have money left over. Often, a couple trading down from a family house to something smaller might be able to avoid a mortgage altogether. But if not, they will need to give careful consideration to the costs of paying off one loan and arranging another. Even where downsizers will have no mortgage at all, they still face costs associated with paying off the original loan. And these costs are on the rise.

One of the largest costs - and one that buyers trading down sometimes overlook - is the penalty attached to paying off their existing mortgage. Fixed-rate, as well as many capped and discounted mortgages have redemption penalties. These can be as high as six months' interest.

For homeowners with older mortgages, these redemption penalties may apply for longer than the fixed or discounted period itself. These "overhanging" penalties are quite rare today, but were much more commonplace in the 1980s and early 1990s.

Lenders normally allow borrowers with a fixed rate, or a mortgage where penalties still apply, to transfer their mortgage to a new home, and to keep the terms of their existing loan. This can be a useful benefit, not least because fixed-rate mortgages are now relatively expensive. A homeowner's existing rate could well be lower than anything on the market today.

The process of transferring a mortgage is relatively straightforward for buyers moving to a more expensive property, as they will usually move the whole of the loan. But borrowers trading down may only want to transfer part of the mortgage. This means paying a redemption penalty on the part of the loan that is paid off.

"Most lenders are prepared to 'port' a loan," says Mark Chiltern, chief executive of Purely Mortgages. "So the first call should be to the existing lender, to see whether you can transfer the mortgage. But if you are taking out a smaller mortgage, you will still have to pay some redemption penalty, even if you keep to the existing terms."

Even borrowers who are not tied in to a special mortgage rate face paying some fees. Charges associated with paying off a mortgage, including so-called "sealing fees", are on the rise, Chiltern says. The going rate for a sealing fee is £95, but some lenders are now charging substantially more. Alliance & Leicester's fees are over £200.

Homeowners who decide to move lenders, as well as move house, will also face costs taking out a new loan, including valuation and legal costs. Fortunately, buyers trading down from a larger property should have a substantial deposit available. This will give them the pick of available interest rates.

But they should pay attention to how they structure any borrowing, not least because not all mortgages are suitable for borrowers later in life. Someone moving to a smaller property in their late 50s or 60s will not want to take on a new 25-year mortgage.

Instead, buyers might want to consider a mortgage that keeps to the same term as they had outstanding on their previous home, or one that takes them through to the year they plan to retire. Homeowners with endowment mortgages might also want to keep to the existing term of their endowment plan, although anyone with an endowment should ideally take independent financial advice before making a decision on what to do with their policy.

According to Simon Jones, director at Savills Private Finance, older buyers do often look for a 10- or 12-year mortgage term, either looking to pay off the loan in full by retirement or linking the mortgage to a lump sum due from a pension or other investment.

And picking a shorter mortgage term also opens up the way to fixing the mortgage rate for the whole of the loan. Lenders such as Northern Rock offer 10-year fixed-rate mortgages, and there are a handful of even longer-term deals on the market. "Taking out a longer-term fixed-rate mortgage can make an awful lot of sense, if the redemption penalties are not too horrendous," he says.

Interest rates on longer-term fixed-rate loans are currently about one per cent more expensive than the best two-year fixed-rate deals, but this is a premium older buyers might be willing to pay. "Short-term fluctuations notwithstanding, interest rates are still quite low," says Chiltern. "And it offers absolute certainty, at a time in life when many people are unlikely to see significant increases in income."