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Money: A User’s Guide
Brokers will try to recommend add-on products while arranging your mortgage – life insurance for example. You will find a better deal by searching elsewhere, so don’t feel pressured by any hard sell (see chapter 9 for more on this).
Choosing a mortgage
What’s actually in a mortgage?
A mortgage is likely to be your biggest financial outlay for the next twenty to thirty years. Choose wisely and you save thousands of pounds. There are a lot of mortgages to choose from, however, so it’s not easy. A broker will help you navigate the market, but first understand what you are signing up for yourself.
How much a mortgage will cost you up front, when you first get accepted for one, and from month to month for the next few years, depends on what that mortgage ‘product’ is made up of and the length of its term. Most are a mix of capital repayment, interest, and arrangement fees. These fees are significant, sometimes several thousand pounds.
The ‘term’ is how long a period you are given to pay back your mortgage. Many are twenty-five years, though the first forty-year mortgages have started to appear. You can lower the amount you pay month on month by opting for a longer term, but longer terms accrue more interest over time. It is a balancing act.
Similarly a mortgage with the cheapest interest rate is not always the cheapest deal over the longer term. You need to work out whether lower arrangement fees mean that you may be better off with a slightly higher interest rate, or vice versa. Banks are clever at making an offer look more attractive with low advertised rates but ultra-high arrangement fees.
Also look out for flexibility. Can you overpay your mortgage without being charged fees if you expect a bumper pay rise in the future? Can you take any break from mortgage payments without penalty if, for example, you know there’s a period when you will see a dip in earnings?
Should you get a fixed-rate or a tracker mortgage?
• BUT FIRST, WHAT IS THE BASE RATE?
The base rate is the national interest rate set by the Bank of England, and it is to the base rate that high-street banks and building societies peg their mortgage rates (as well as their savings rates, see chapter 5).
Following the Crash, the base rate was cut to a historic low of just 0.5 per cent, where it stayed until 2016, when it fell even further to 0.25 per cent. Low interest rates can help to revive the economy, they are good for businesses – borrowing is cheaper – and should make citizens spend rather than save. It is rising at the moment slightly, but is still at record lows. Young first-time buyers have never known anything other than cheap interest rates on mortgages, but it may not always be this way. In 1990, the base rate was nearly 15 per cent, in 1980 it was 17 per cent.
Variable rates, pros and cons
When choosing a mortgage one of the biggest decisions is whether to get a variable rate, a tracker-rate mortgage or a fixed-rate mortgage.
A variable rate is fairly self-explanatory. The mortgage lender sets the price of its variable rate and may at any point raise it or lower it; variable rates will rise when the base rate rises, but banks may set them as they like. All lenders will have a ‘standard variable rate’ (SVR), which is their default product that you will revert to whenever the special deal you might sign up for, say a two-year tracker, ends.
The SVR is usually more expensive than the best mortgage deals on the market, so it pays not to sit on it for any length of time, though many people do. Recent research by mortgage broker Dynamo suggested that a third of people whose mortgage deal expired in 2017 spent forty-two days on the SVR, which cost an average of £371 more than they needed to be paying, in ‘procrastination penalty’.
A tracker rate is a variable-rate mortgage, but one that is actually pegged to the base rate. So for example you might have a tracker-rate mortgage of 1.99 per cent, which would work out at an interest rate of 2.49 per cent when the base rate is at 0.5 per cent, and rise to 2.99 per cent if the base rate rose to 1 per cent.
The cost of your mortgage rises proportionally with the base rate. You can sign up to a tracker with various different lengths: a lifetime tracker runs for the full term of your mortgage, say twenty-five years, or you could have a two-, three-, five- or ten-year tracker.
Fixed rates pros and cons
Fixed rates do not alter with the base rate. You lock into a specific rate for a set period – two, three or five years normally, but increasingly ten-year fixed rates have come onto the market. Whether you go for a variable or a fixed rate comes down to how much you want to bet on base rates rising or falling. Fixed rates are best for people who want the certainty of knowing exactly how much they must pay month by month for their mortgage for the next few years, but they may be slightly more expensive. You need to make a clear-eyed decision, because you will pay high exit fees to get out of your deal, whether it is fixed or tracker: as much as 5 per cent of your mortgage in what is known as an early repayment charge (ERC).
You may also be charged an ERC for paying off a chunk of your mortgage at once, for example, if/when you win the lottery. Some deals let you overpay a certain percentage a year if you can afford to, but there is a limit.
When weighing up your options, consider that every time you move deal you will probably have to pay arrangement fees. If you are signing up for an inexpensive-seeming two-year deal, factor in that you will have to soon pay out arrangement fees when it comes to an end and you want a new rate.
On the other hand the downside of signing up for a deal that is very long, say a ten-year fix, is that you may struggle to transfer it to a new house if you intend to move. Some mortgage deals are ‘portable’, but if your circumstances have changed since you took it out, or your bank does not like the look of your new place, you may struggle.
Watch out for any small print that allows a bank to put up its tracker rates even when the base rate does not rise. Some have a ‘collar’ that stops your rate falling too low if the base rate falls below a certain minimum.
Buying with the Bank of Mum and Dad (BOMAD): top tips and family mortgages
The Bank of Mum and Dad became the UK’s ninth-biggest unofficial mortgage lender, in 2017 helping to fund 26 per cent of all UK property transactions, on a par with Yorkshire Building Society, according to research by Legal & General. Of those under thirty-five seeking to buy in 2017, 62 per cent were being partially bankrolled by parents or other family members.
This has bred a new category of family mortgages. David Hollingworth, of broker London & Country, says you should not necessarily head straight for something badged up a first-time buyer deal – a normal mortgage might be cheaper or more appropriate. Nevertheless if you are struggling with a deposit there are some innovative solutions.
Barclays Family Springboard will lend as much as 100 per cent LTV as long as your parent will lock 10 per cent of the property price (i.e. the 10 per cent deposit they might otherwise have given you) in cash into a linked savings account as additional security. This means your parent keeps their cash in their name rather than giving it to you, and will be able to access it at a later date, within three years, assuming you make all your mortgage payments on time.
Post Office’s Family Link gives you the opportunity to take out two mortgages on two properties, 90 per cent LTV on the one you want to buy and 10 per cent against your parents’ home. You the buyer pay off both loans, but the 10 per cent one is interest-free, though you have to clear it within five years. You must be a first-time buyer to take advantage of this, and your parents must have an income of at least £20,000.
Aldermore has a similar concept, a Family Guarantee mortgage, again at 100 per cent LTV, which allows parents to use spare equity in their own home as security, rather than cash, as do Family Building Society and Bath Building Society. The major drawback of these is that your parents’ home is at risk of being repossessed if you cannot pay your mortgage, which could make for some tense Sunday lunches. They are also more expensive than conventional mortgages. If your parents can afford to give you cash instead, you will get a better interest rate.
If your parents or grandparents are giving you some or all of your deposit in cash, lenders will want to know whether it is a gift or a loan, and whether the money has any strings attached, such as having to repay them monthly. This will affect the perceived affordability of your mortgage and therefore how much you can borrow. A ‘soft loan’, which is where your parents expect to be repaid, but only when you sell your property, therefore no monthly repayments are required, is not a problem. Banks will often require a letter from your parents confirming that the money is a gift, or a ‘soft loan’.
First-time buyer schemes to help you buy (with or without BOMAD)
You can take advantage of the following options whether or not you have money from your parents. If you are saving up to buy your first home use either a Lifetime ISA or Help to Buy ISA and you get some free cash from the government. See more details in savings chapter 5.
Help to Buy Equity loan
This government scheme has been extended to run until 2021. The idea is to help those with small deposits to access bigger homes and better interest rates. By its terms, you have to buy a new-build property from an approved house builder, with a 5 per cent deposit, receiving a 20 per cent loan from the government. This means you can take out a 75 per cent LTV mortgage; those buying in London receive a 40 per cent loan, so they need borrow only 60 per cent LTV.
The 20 per cent loan is interest-free for the first five years, then you have to pay interest at initially 1.75 per cent, a rate which increases in line with CPI inflation (for more on what that is, see the savings chapter 5). In exchange, the government, like the bank, owns 20 per cent of your property. You pay this off if and when you move, or you can pay it off sooner if you have managed to save the money.
Your mortgage should be a lot more affordable because you have a lower LTV despite your small 5 per cent deposit. Typically monthly payments are reduced by a third compared with what you would be paying with a 95 per cent LTV. As a result many first-time buyers using Help to Buy have been able to afford a slightly bigger property. There is a limit on how much you can pay for your home. In England this is £600,000, in Wales, £300,000. In Scotland £200,000.
One of the downsides is, as some people who took out their Help to Buy loans five years ago are now finding, that if your property does not appreciate in price much you may struggle to repay the government stake and buy another home. If you sell you may find that you have gained little. Many will sign up for Help to Buy assuming that they will use the increased value of their property to remortgage and pay off the equity loan. There are also complaints that those who come to the end of their original Help to Buy mortgage term may struggle to remortgage on to a better deal; there are fewer Help to Buy eligible remortgage products available.
You can find more details on the Help to Buy website (helptobuy.org.uk).
Shared ownership
If you cannot afford a whole property you can actually buy part of one, from just 25 per cent of it to 75 per cent of it, through the shared-ownership scheme. You rent the rest from a housing association, as long as you earn less than £80,000, or if you are buying in London, £90,000. This is per household though, so combined income if you are a couple. You can search for eligible properties on sharetobuy.com.
Take a three-bedroom flat available in Cambridge. Its full price is £415,000 but you can buy a 30 per cent share in it for £124,500, which requires a mortgage deposit of just £6,225. Your monthly cost would be £1,407, made up of a £624 a month mortgage, rent of £666 and a service charge of £117. Sounds like just the solution, but there are a lot of catches with shared ownership, so do your research to see if it actually suits you.
First, that massive service charge. Though you own only, say, 30 per cent, you have to pay 100 per cent of the service charge, which is a monthly charge you pay the housing association for maintenance. Service charges are infamously expensive, and notorious for rising steeply. Likewise, rents on the proportion you do not own may also rise and become less affordable, though rents are less than would be charged on the open market – usually 2.75 per cent of the property value per year. You can start to buy more shares in the property, up to 100 per cent of the whole thing, in a process known as staircasing, but again, if property values rise you may not be able to afford to do this. Also you may be limited to how many times you can ‘staircase’, so you couldn’t for example buy just 1 per cent each year.
Shared-ownership mortgages come with higher interest rates than conventional mortgages. There are also certain restrictions on what you can do with your home because, really, you are still considered a tenant. You cannot sublet it, for example, which makes life a bit difficult if you have to move elsewhere for work. If you fall behind on rent there is the risk you will lose the property.
You can always sell and realize any gain you have made on the portion you own, supposing that house prices have risen, but the housing association has a right to find a buyer before you sell through the open market.
Debt is a dirty word, so much so that a long time back the financial services industry rebranded it as the much more enticing ‘credit’. But although many of us often called ‘generation debt’ are up to our eyeballs in it, not all debt is created equal, or owed equally urgently. You should not unnecessarily freak yourself out about borrowing money to the detriment of its many positive benefits (your own flat, university degree, iPhone, car, good credit score) or of getting a decent night’s sleep.
Wrapping your head round how to borrow well is also one of the most efficient ways to avoid wasting money, which is why I think it is a topic worth addressing ahead of how best to budget, or start a savings account or pension. There is no point in having money set aside if you are paying out hundreds of pounds in interest on overdraft or credit-card debts because you have not managed to clear them quickly enough.
If you were to borrow £3,000 on a credit card, with an interest rate of 19 per cent (some credit cards now charge interest rates of over 50 per cent), and only make the minimum repayments, starting at £74 a month and reducing over time, it would take you twenty-seven years and seven months to pay it off, and you would have paid an additional £4,192 in interest in the meantime, highlighted the Financial Conduct Authority, the financial services industry regulator. That £3,000 would have cost you £7,192. If you could stretch to repaying £108 a month, by not saving until the debt was cleared, for example, you would get rid of it in three years, and pay £879 in interest. The debt would have cost you £3,879.
I will come on to how best to have and use credit cards, but, having dealt with mortgages, I’ll start with the second-biggest debt you are most likely to be juggling – a student loan. Ironically, that is the debt that should cause the least insomnia. I will then outline the debts that are far more pernicious, and how best to handle them in a way that helps you save money.
If you are mired in really messy debt with a bank or similar lender there are things you can do and people available to help you out of it, so please don’t let it harm your mental health. I have covered this in chapter 11 on money and wellbeing.
Student loans
Putting aside all the controversial politics of whether or not students should have to pay tuition fees, and the rising cost of living at university, you have to admit that student loans have suffered from a shocking PR job. We have all read the news reports about bright young people being forced into £50,000 of ‘debt’ that they will be lumbered with for the whole of their twenties, thirties and forties, at least. While this is technically true, the implications are often misunderstood. The connotations of the dirty D word can be dangerously offputting, especially if you have grown up in a household stalked by debt, or cannot rely on BOMAD to bail you out.
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