How to choose a mortgage
Your home is likely to be the most expensive purchase you ever make and with the majority of us not wealthy enough to buy our properties outright a mortgage is the only way to fund it. But while you'll quickly know when you've found a place you can call home, a loan doesn't tug on the heartstrings in quite the same way.
So where do you start in the search for the perfect mortgage? "For most people, the focus is rate but it's far more complicated than that," says David Hollingworth, associate director of communications at mortgage broker London & Country.
Type of mortgage
One of your first decisions will need to be the type of mortgage you go for. As their name suggests, repayments on fixed-rate mortgages are set for a certain period of time – typically two, five or 10 years – giving you the piece of mind that your repayments won't go up if interest rates rise (conversely, they won't fall either).
Alternatively, you can go for variable rate mortgages where your repayments can move up or down, depending on what is happening in the wider economy. Discount mortgages offer a reduction on the lender's standard variable rate (SVR), again for a set period
While these rates are likely to be heavily influenced by interest rate movements, changes are ultimately at the lender's discretion. By contrast, (now more common) tracker mortgages charge a rate that is a fixed percentage above bank base rate, meaning they mirror its movements exactly.
However, while there are a variety of mortgage types to choose from, with interest rates set to rise borrowers only have eyes for fixed rates. "At the moment, 90% or more of the mortgages we sell are fixed rates," says Hollingworth.
Traditionally, these deals are more expensive than variable rates but with competition in the market so intense, borrowers no longer need to pay a premium for peace of mind. "Fixed rates are so competitive at the moment, there is very little in it," he adds.
Along with the type of rate you choose, there is the question of how long you want your deal to last. When your fixed or discounted rate expires, you'll be moved on to your lender's higher SVR unless you remortgage on to a new deal.
Many settled borrowers like the idea of longer-term deals that free them from the need to regularly remortgage. "We're seeing a lot of people fixing for as long as 10 years," notes Hollingworth, "but five-year deals are also popular."
Andrew Montlake, a director at broker Coreco, adds: "I'm a massive believer in five-year fixes at the moment as they're so cheap. You can expect to pay just 2.5% or as low as 1.99% if you have a 40% deposit."
Most deals are fully portable, meaning that if you move house your loan can move with you. However, if your circumstances have changed and you do not meet your existing lender's criteria for further borrowing, you may need to redeem your current loan to go elsewhere and face early redemption charges.
"Two- to three-year deals leave your options open," says Hollingworth.
Alternatively, if you don't want to switch at all you could plump for a competitively priced lifetime tracker that you can keep for the life of your loan.These can be a flexible option – without any early redemption penalties, you can easily switch to a fixed rate if you change your mind.
Remember: whatever the deal you go for, the more security you can put up – whether that's a deposit on your first home or equity in your existing property – the lower the rate you'll be eligible for. "The smaller your deposit, the higher rates will tend to be," says Hollingworth.
However, it's important not to get blindsided by rates, as fees can take the shine off an otherwise great deal. On the lowest rates, you may have to pay between £1,500 and £2,000 in fees, warns Hollingworth.
But as hard as these fees may be to swallow, they may be worth paying if you have a larger mortgage or are taking a longer-term deal, because you'll easily recoup the money through lower interest payments. However, it may make less sense for smaller loans over shorter time frames.
It's easy to do the maths – just tot up the cost of fees along with your monthly repayments over the term of the deal to reveal its total cost.Thankfully, most lenders do offer a variety of fee/rate combinations so you should be able to find something to suit you.
Moving or remortgaging
Remortgage customers, who are just switching deals rather than buying a new property, should consider deals with incentives, such as free valuations and legal work.
Whether you're moving home or remortgaging, if you have a decent amount of savings it may make sense to consider an alternative type of mortgage that lets this cash work for you. Offset mortgages allow you to hold any cash savings you have alongside your mortgage to reduce the size of the debt you're paying interest on. So although you won't earn any interest on your savings, you will pay less interest and will be able to clear your loan faster.
In some cases, they can even work well for first-time buyers. Yorkshire Building Society, for example, allows borrowers to link as many as three savings accounts to the loan, meaning parents or other family members can use their savings to bring down your repayments.
"They are only giving up 1% or so in interest but the impact on your mortgage can be huge," says Tanya Jackson, corporate affairs manager for the building society.
Whatever type of loan you end up choosing, it pays to be aware of the new rules that came into force last year as part of the Mortgage Market Review. "In addition to seeing payslips and bank statements, lenders will also be asking about loans and credit cards as well as how much you spend on childcare, travel and utilities," says Hollingworth. As such, borrowers need to keep a close watch on their finances for a few months before making their application.
But it's not just the lender's responsibility to work out whether you can afford the loan. If you are to truly enjoy your home, you need to be confident you'll still be able to manage your payments in the years to come. "Think about your future circumstances and outgoings," says Jackson. "Remember you are buying when rates are at rock-bottom and the chances are they won't be when you come to remortgage in two to five years' time."
Questions to ask before you pick your loan
How long will you stay in your home?
It may not make sense to commit to a longer-term fix for a first flat you may only stay in for a couple of years.
Will your disposable income increase or decrease in the coming years?
Balance possible increases to your salary or bonuses with new expenses that may arise such as childcare and a drop in income if you plan to start a family.
Are large fees wiping out the benefits of a low rate?
Rather than just compare loans based on rate, consider the total cost based on monthly repayments plus fees over the term you'll keep the mortgage to get a more accurate picture.
Can you overpay?
If you are likely to receive bonuses or receive another lump sum such as an inheritance, check you'll be able to pay down your mortgage without penalty.
Every mortgage lender has a standard variable rate of interest, or SVR, on which it bases all its mortgage deals, including fixed and discounted rate and tracker mortgages. When special deals come to an end, the terms of the deal usually state that the borrower has to pay the lender’s SVR for a period of time or pay redemption penalties. The lender’s SVR is, in turn, based on the Bank of England’s base lending rate decided by the Bank’s Monetary Policy Committee (MPC). Every time the MPC raises its rate, mortgage lenders generally increase their SVR by the same amount but when the MPC lowers its rate, lenders are often slow to pass this on or don’t pass on the full cut to borrowers.
Changing mortgages without moving home. Property owners chiefly remortgage to get a better deal but some do so to release equity in their homes or to finance home improvements, the costs of which are added to the new mortgage. Even though you’re not moving house, you still need to engage solicitors, conveyancing and the new lender will require the property to be surveyed and valued.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.
Early redemption charges
You may think a lender would be grateful to you for paying off your debts early. Alas, no. Mortgages and loans levy early repayment (or redemption) charges because the profitability of your loan or mortgage to the lender is calculated on the basis that you’ll pay every payment (see APR). To pay the loan/mortgage off early – even to remortgage – means the lender will make less profit and so claws back potential lost profit with an ERC, which could be three months’ interest. The earlier into the term you repay the loan, the higher the ERC might be.