Mortgage basics

In times gone by, applying for a mortgage was relatively straightforward. A far more limited range of products was available than is the case today, lending criteria were stricter, and most aspiring borrowers would simply approach their bank or building society.

This article provides some background to the current complex mortgage market. Before making any decisions on mortgage matters, we recommend you consult a suitably qualified professional, such as an Independent Financial Adviser (IFA).

How much can I borrow?

This usually depends on how much you earn (most lenders will wish to see proof), how much the lender considers you are likely to be able to afford (taking into account other loans, household bills and so on), and the value of the property you are buying.

For a single person, a loan of up to 3.5 times annual earnings used to be standard, but some lenders now offer multiples of 4 or even 5 times – the latter generally to high-fliers only. The typical multiple for a couple is 2.5 times joint earnings.

Most mortgage companies will lend up to 75 per cent of the value of the property you are buying, but some will lend 95–100 per cent. Loans of as much as 125 per cent of value are available, but borrowing on this scale is unwise for the majority of people.

Tempting though it may be, when you have found the home of your dreams, to borrow the maximum a lender is prepared to offer, it’s important to be realistic and only borrow what you are confident you can afford.

Types of mortgage

Though there are a host of different mortgages on offer, all of them fall into one of two categories: repayment and interest-only.

• Repayment: the monthly payment includes part of the sum borrowed, plus interest on the loan

• Interest-only: as its name suggests, the monthly payment consists purely of interest on the loan

In other words, whereas a repayment mortgage guarantees you outright ownership of your home at the end of the mortgage term, with an interest-only mortgage you will still owe the whole of the sum you initially borrowed.

Interest-only mortgages are attractive to many borrowers, because the monthly payments are lower. They can work well – as long as you make realistic provision for paying back the loan at the end of the term. This can be done through an ISA or other savings plan, or via an insurance policy.

The endowment mortgage debacle, which left many homeowners facing the dismal prospect of being unable to pay off their loans, shows the pitfalls of this type of mortgage. Unless you are confident of being financially aware and disciplined, the repayment option may be best for you.

Paying interest

As well as the type of mortgage, you’ll need to consider the best interest payment arrangement for your circumstances and temperament.

• Variable: your payments vary with the Bank of England base rate. If it falls, you pay less. If it rises, you pay more

• Fixed: the rate of interest remains the same for a specified time (generally between one and five years). Thereafter, a variable rate is payable. On the plus side, this type of arrangement helps you to budget during the early years of borrowing, and it protects you against rate rises. On the minus side, if rates fall, you may end up paying more than you would have done with a variable rate deal

• Capped: there is an upper limit on the rate of interest you pay over an agreed term. There is, however, no lower limit, which enables you take advantage of any decrease in rates. This can be useful in planning your expenditure, but bear in mind that interest rates are usually higher than with a fixed-rate mortgage

Whichever you choose, the total amount of interest you will pay depends in large part on the duration of the loan. A shorter term may appear more expensive than a longer one, as the monthly payments will be higher, but it can, in fact, work out cheaper over the years.

Getting a mortgage

Depending on personal preference, you can:

• Approach banks, building societies and other potential lenders direct, in person, by phone or online. Some only sell their own product ranges, but this is now changing

• Talk to an IFA. In the past, advisers were paid through commission on products sold, which sometimes provoked allegations of bias. Nowadays, many offer fee-based services

• Consult a mortgage broker. There are three types: the tied broker, who only offers products from one specific lender; the multi-tied broker, who offers products from a number of lenders; and the independent broker, who can offer products from all lenders. As with IFAs, charging systems differ

Mortgage brokers and IFAs are regulated by the Financial Services Authority (FSA). They have a duty to recommend the best choice for clients’ particular circumstances, irrespective of personal gain.

When evaluating different mortgage deals, it’s important to compare like for like by getting each potential lender to quote for the same sum of money borrowed over the same term. Be alert for penalty clauses, which some lenders impose if you pay off your mortgage before the end of the agreed term.

© 2007 of Re:locate magazine, published by Profile Locations, Spray Hill, Hastings Road, Lamberhurst, Kent TN3 8JB. All rights reserved. This publication (or any part thereof) may not be reproduced in any form without the prior written permission of Profile Locations. Profile Locations accepts no liability for the accuracy of the contents or any opinions expressed herein.