Interest Rates on Mortgages
When you have chosen the right mortgage for you, whether it be a repayment or an interest only mortgage, you will need to consider the 4 main mortgage rate options available.
• FIXED
• CAPPED
• DISCOUNT
• VARIABLE
Fixed Rate Mortgage
The amount you repay the lender each month can be at a fixed interest rate for a certain period of time, regardless of the interest rate in the market place. It is common for lenders to offer rates fixed for a period of 2 to 5 years, but shorter and longer periods can be found in the market. At the end of the fixed rate (or ‘benefit’) period the rate will normally convert to the lenders Standard Variable Rate (SVR).
It is normal for lenders to charge up-front fees in the form of booking and/or arrangement fees. In addition lenders frequently apply an Early Redemption Charge (ERC) for fixed rate mortgages. This acts as a ‘lock-in’ making an often heavy charge for borrowers paying off their mortgage early though not all fixed lock in rates have redemption penalties. Watch out – the ERC can sometimes last longer than the fixed rate period e.g. a 3 year fixed rate with a 5 year ERC.
Capped Rate Mortgage
A capped rate mortgage is very similar to a fixed except that if the variable rate drops below the capped rate, the borrower will make payments based on the lower variable rate. However should rates increase the payments will be ‘capped’ and will not rise over the capped rate. So in our opinion as a rough ‘rule of thumb’ a capped rate is better to have than a fixed if all other factors are equal. Again, as with fixed rates, up-front charges and ‘lock-ins’ are common.
Discounted Rate Mortgage
The Lender offers a discount on the Standard Variable Rate (SVR) for a specific period of time. For example, the variable rate may be 5% with a discount of 1.5% The initial pay rate would therefore be 3.5% If the variable rate rose to say, 6% then the rate payable would rise to 4.5 As the discount is linked to the standard variable rate, the borrowers payments will increase, if rates rise – so there is no certainty in budgeting. However should rates decrease the borrower will benefit from lower payments.
It is still possible to have up-front charges for discounted products and an Early Redemption Charge is common.
With discount mortgages borrowers need to watch out for ‘payment shock’. Some short term discount products offer a ‘deep discount’ e.g. 4off for 1 year. In such circumstances the borrower will be facing a significant increase in their monthly mortgage payment at the end of the discount benefit period.
Variable Rate Mortgage
Borrowers paying the Standard Variable Rate will have their payments increase or decrease as the lender adjusts the rate in accordance with market conditions.
Features and Benefits.
There are other key features and benefits to be considered when determining the best mortgage for a prospective borrower.
FLEXIBLE / LIFESTYLE MORTGAGES
CURRENT ACCOUNT MORTGAGE (CAM)
CASHBACK
FREE LEGALS OR CONTRIBUTION TOWARDS CONVEYANCING COSTS
FREE VALUATION OR REFUND OF VALUATION FEE
OTHER BENEFITS
Flexible / Lifestyle Mortgages
A Flexible or ‘lifestyle’ mortgage is designed to let you to make extra repayments when you have extra money, and to reduce or even skip payments when necessary. Borrowers will normally have to build up a reserve through overpayments before being allowed to underpay or skip payments. The main benefit of flexible mortgages is that many schemes are offered on a Daily or Monthly Interest Calculation basis (sometimes referred to as ‘daily rest’ or ‘monthly rest’). Until the arrival of flexible mortgages most, if not all, UK lenders were charging interest on an annual basis which meant that borrowers making over-payments were not getting the benefit straight away because it could be a year before the capital was reduced by the over-payment. Whereas, on a mortgage where the interest is being calculated on a daily basis, any over-payment reduces the mortgage balance immediately hence the borrower will be charged less interest from the next day. Without going into detail to explain this feature the up-shot is that over-paying the mortgage on a monthly or regular basis, even by a relatively small amount, will reduce your mortgage term by years (hence saving payments).
Many flexible mortgages come without any Early Redemption Charge so the borrower is not ‘locked-in’ to any particular lender. In addition the interest rate charged is often lower than the usual Standard Variable Rates charged by the other more ‘traditional’ mortgage lenders.
The flexible mortgage concept was imported from Australia so occasionally you may hear them referred to as ‘Aussie style mortgages’.
Other Benefits
A whole range of other benefits can be applied to mortgages including the significant benefits of no Mortgage Indemnity Charge and no Early Redemption Charge. See below for more information about these features.
Other Features/Conditions and charges associated with mortgages.
Early Redemption Charge (sometimes referred to as a ‘redemption penalty’)
Given that the mortgage market is very competitive many mortgages are sold as ‘loss leaders’ i.e. the mortgage has to be held for a number of years before the lender breaks into profit. As a consequence lenders frequently ‘lock-in’ borrowers by applying Early Redemption Charges for those paying off the mortgage early. Charges can be significant e.g. 6 months interest or repayment of the amount of benefit received, be it cashback or reduced interest. The period an Early Redemption Charge applies can vary. Sometimes it will match the period of the discount/fix but often it can go beyond the benefit period e.g. a 5 year discount with a 7 year ERC. This is referred to as a ‘redemption overhang’.
On this subject see ‘No Redemption’ and ‘No Overhang’ below.
No Redemption
Selecting the 'No redemption' option means that the mortgage schemes on screen will allow you to repay the loan in full at any time without applying an Early Redemption Charge.
Most mortgage schemes, in return for offering you a lower initial rate, will require you to stay with that scheme at least for the period of the Discount, Fix or Cap, and often longer. If you wish to repay the loan in this time, or you remortgage with another lender, you will have to pay an Early Redemption Charge which can cost £thousands (6 months interest is common) depending on the lender and scheme.
With 'No Redemption' mortgages you will not have to pay this redemption fee (although there may still be other costs such as sealing fees and legal fees.) As a consequence of not being ‘locked-in’, the rate offered on these schemes will usually not be as competitive as for mortgages with redemption penalties, making them most suitable for those who are likely to keep track of current rates and wish to remortgage quickly if they find a better rate, or those who may have to repay their loan in the first few years.
No Overhang
Selecting the 'No overhang' option means that the mortgage schemes on screen will allow you to repay the loan without penalty once the benefit period has ended i.e. the mortgage does have an Early Redemption Charge but it does not last longer than the fixed, capped or discount period. This means that a mortgage with, for example, a discount to 31st January 2006 will have a redemption charge to either the same date or a date prior to this.
The Early Redemption Charge can represent a significant sum although the amount will differ between lenders and between products. With 'No overhang' mortgages you will only have to pay this redemption fee if you redeem the loan or remortgage whilst you are still subject to the scheme's special rate. Once you have reverted to paying the lender's Standard Variable Rate (SVR) you will be able to redeem the loan without penalty (although there may still be other costs such as sealing fees and legal fees.) As a consequence of not locking-in the borrower to the lender's SVR, the rate offered on these schemes will usually not be as competitive as for rates with redemption overhangs, making them most suitable for those who wish to benefit from a lower initial rate without needing a very low initial rate, and who are likely to want to remortgage to another Discount, Fix or Cap once they are no longer benefiting from the initial rate.
Mortgage Indemnity Charge (sometimes referred to as a High Percentage Lending Fee)
For high Loan to Value (LTV) mortgages i.e. where the loan is not much less than the value of the property, it is common practice for the lender to take out a form of ‘insurance’ to protect against some or all of the losses incurred if the property needs to be taken into possession because of serious arrears. It is common practice for lenders to pass this charge on to the borrower. Depending on the amount of loan and the LTV the Mortgage Indemnity Guarantee (MIG) charge can be a significant cost e.g. a £47,500 mortgage on a purchase price / valuation of £50,000 would result in a £750 charge on a typical MIG charge of 7.5 percent on a normal lending limit of 75 percent loan to value. Most lenders have a different name for this charge i.e. it may not appear on the mortgage Offer as Mortgage Indemnity Charge or High Percentage Lending Fee.
There are some important facts to understand about the mortgage indemnity charge. It acts as a form of insurance for the lender not the borrower. This means that the lender can claim part or all of its ‘losses’ incurred repossessing the property from the insurance company providing the MIG cover. Note that even after repossession the former borrower will remain liable for any sums owing (shortfall between selling price and mortgage outstanding plus arrears, lenders legal costs and any other charges applied to the mortgage) and can be pursued by the insurance company for payment at a subsequent date.
Valuation Fee
The amount charged to conduct a valuation of the property on behalf of the lender. It is important to note that the valuation is carried out on behalf of the lender – not the mortgage applicants! Frequently lenders include an administration fee as part of the valuation fee collected to cover the costs of arranging the valuation. The valuation does not represent a detailed inspection. For peace of mind it may be appropriate to obtain a ‘Housebuyers Report’ or a ‘Full Structural Survey’. These are more detailed than a lender valuation but they produced on behalf of the applicant. They are more expensive than the lenders valuation.
Booking & Arrangement Fees - up-front fee charges levied at the outset of the mortgage.
A booking fee will normally be required with the application form. A booking fee is paid to reserve funds on a mortgage product that has limited funds available e.g. a first-come, first-served fixed rate. Booking fees are often non-refundable, so if the mortgage applicant cancels the mortgage application before completion the fee will not be reimbursed.
An arrangement fee is typically charged on completion of the mortgage. Arrangement fees are common on fixed and capped rate mortgages. Frequently they can be added to the mortgage hence the fee does not become an ‘out of pocket’ expense.
Legal Fees
It is necessary to have a solicitor or licensed conveyancer to act on behalf of the mortgage applicant and the lender in the house purchase or remortgage transaction. The costs will be greater for house purchase than for remortgage. It is the role of the solicitor or licensed conveyancer to note ownership of the property on the title deeds; note the lenders interest in the property; register with the Land Registry and conduct searches to identify if there may be factors which could affect the property e.g. coal mining search to check for subsidence; check to see if there are some planned major road developments going through the back garden etc.
Lenders will insist that the property is adequately insured, with a suitable Buildings Insurance Policy, as it represents security against the mortgage debt. A buildings policy covers against storm damage, fire, flooding etc and relates to the fabric of the house or flat etc. It is normal for lenders to check that any policy arranged is adequate and a fee will sometimes be levied to check the policy, if the borrowers take a policy other than the one sold or recommended by the lender. In addition, borrowers may chose to take out a Contents Policy that provides cover for the contents, such as carpets, TV’s, furniture etc. Most lenders and insurance companies offer a combined Buildings and Contents Policy. In the past some lenders have made their insurance compulsory with some very competitive mortgage products although this is less common now.
Another form of insurance common in the mortgage industry is a Mortgage Payment Protection Plan. This policy is designed to pay the mortgage premium. This form of insurance has become more important as the Department of Work and Pensions has steadily withdrawn the benefits available. This form of insurance is not compulsory.
Another form of insurance is Mortgage Indemnity Guarantee. This is covered above.
There are a whole series of other fees that some lenders apply in certain circumstances e.g. arrears, late payment, removing the lenders name from the Title Deeds at the end of the mortgage. Under the terms of The Mortgage Code of Practice the lender will, before a mortgage applicant takes a mortgage, provide a tariff covering the repayment of the mortgage, including charges and additional interest costs payable in the vent of arrears and will advise of any other charges for services before or when the service is provided.
