About Mortgages Mortgages are loans from financial institutions
which help people buy, and eventually own their own property, be it a flat, a house or something more unusual. There are two main aspects to taking out a mortgage: - choosing the type of mortgage to have;
- choosing the lender who will advance that type of loan to you.
These are both important decisions on which you need to form a view. All mortgages involve taking out a large loan to be repaid over a long period of time,
typically 20 - 25 years. Your choice of repayment method is usually between: - repaying the capital sum of the loan gradually over the mortgage period; or
- using an investment-linked method, such as a life insurance endowment or perhaps an ISA (Individual Savings Account), to repay all the loan at the end.
Remember that a house or flat is a home, not an investment. If you cannot keep up the repayments, you may lose it. Furthermore, even if house
prices go up and you make a gain, you will still need somewhere to live if you sell to realise the gain.
Repayment mortgage With a repayment mortgage you make regular payments, normally monthly, to the lender. These
payments are made up of interest on the outstanding loan and repayment of part of the capital sum of the loan. In the earlier years, most of your payments cover the interest with only a small part for repayment of the capital. As the outstanding loan is reduced, the interest element falls while the repayment part increases. Provided you keep up with the payments, your loan will be fully repaid at the end of the mortgage term. This is the great attraction of a repayment mortgage.
You will usually be asked to take out life insurance so that in the event of your death the remaining mortgage will be paid off. This is essential if those living with you depend on your income to pay the mortgage. For most repayment mortgages, interest is charged on the balance outstanding at the start of the year, and the interest charged in the year will not be reduced if you make extra repayments after this date. If
this applies to your account, you should retain any amounts you are planning to use to accelerate the repayment of your loan in an interest-bearing account until you make the payment shortly before the end of the year. Furthermore, in the final years of a repayment mortgage when your payments largely go to repaying capital, it may pay you to switch your borrowing to another source which takes proper account of payments in the year. Endowment mortgage
With an endowment mortgage, the repayments to the lender are made up of interest on the loan only. The loan stays unchanged throughout the mortgage term. Interest is payable on the total amount of the loan during that period. In order to pay off the capital sum owing at the end of the loan period, you will be expected to take out a life insurance endowment policy for you or your partner. This may be provided by the lender. It
is important that you ensure that this policy is kept up to date. This is your responsibility, not the lender's. There have been, after the death of a partner, many incidences of borrowers discovering that a policy had lapsed. The investment element of the endowment policy is managed on your behalf by the life insurance company. The assumption is that the investment element will grow over time to yield a capital sum
sufficient to pay off the loan at the end of the 20 or 25 year period. This may not, however, be guaranteed. There are three basic types of endowment mortgage - with-profits, unit-linked and unitised with-profits.
With-profits endowment mortgage
Your premiums, less charges, are pooled with those of other policyholders and invested by the insurance company. What you get back is at the discretion of the insurance company. Your policy is accorded an annual (reversionary) bonus which is set by the company after 'smoothing'. This means that some of the investment profit from good years is held back to cover years when investment returns are poor. In addition, you get a final (terminal) bonus at the end of the mortgage period. This is
usually substantial, although again the level is decided by your insurance company. The intention is that your accumulated annual bonuses and the final bonus should pay off the mortgage loan. Unit-linked endowment mortgage Your premiums, after charges, are invested on a unit basis in specific investment funds run by the insurance company. Your return will depend solely on the performance of those funds, which is based
on the stock market and other conditions. There are no discretionary annual or final bonuses, and no smoothing. As a result, your return, either when the policy matures or if you decide to cash in early, will be more volatile than with a conventional with-profits policy. Unitised with-profits endowment mortgage These endowments are a hybrid of the two other schemes. Your premiums are again invested in units,
but the value of the units and your returns are determined by the insurance company in much the same way as with a conventional with-profits policy.
ISA mortgage ISA mortgages have now started to be offered. The industry geared itself up for a seamless change
from PEP to ISA mortgages (as people had taken out PEP mortgages in the past). The reality is that taking out a new ISA mortgage is not such a simple process. The MORI poll found that the majority of British investors are confused by ISAs. The association for Unit Trusts and Investment Funds (AUTIF) has called on the government to simplify the new accounts; and a leading mortgage broker, John Charcol, has warned clients against
using ISAs because it is worried about their complexity and lack of guarantee that they will continue beyond ten years. Making your choice of mortgage As mortgage loans of all three types are often for a lengthy period such as 20-25 years, or even longer, there is no absolutely best choice. In that time all sorts of financial changes can occur. Each type has advantages and disadvantages.
All types of mortgage involve repaying interest on the capital, though with a repayment mortgage, the interest component gets less as the capital is repaid. Accordingly, they are all vulnerable to changes in general interest rates, as the interest rate you pay varies at the discretion of the lender. Although the interest rate may in all cases be fixed, or discounted for a period at the start of the mortgage, variable rate mortgages are the most common.
It is very important to take care that you do not take out too large a mortgage, which leaves you vulnerable to the higher repayments that will come if interest rates rise.
Mortgage interest rates at the time of writing are around 6-7%, but over 25 years they may go to
much higher levels at some point. This caution is reinforced if two people, perhaps a married couple, are buying a property together and both incomes have counted towards getting the loan. Remember that you may not always have two incomes. Try to consider how you would manage on only one. If you are offered special deals, you should also take care that you consider the size of payments when they return to their normal level. It is too easy not to look ahead beyond the
immediate period when the discount, the cashback or the low-cost start applies. With a repayment mortgage, your loan will be paid off if you keep up the monthly payments through periods of both high and low interest rates. If that certainty is important to you, a repayment mortgage may be the best option. With an endowment mortgage or ISA mortgage, however, there is no guarantee that your investment
managed by the lending company will make enough to pay off your mortgage. You could end up with a surplus, perhaps substantial, if your policy is particularly successful. But you could end up with a shortfall and have to find money elsewhere to pay off your mortgage. Your insurance company should keep an eye on your investments and, if necessary, increase your premiums to avoid or reduce any shortfall, but remember that investment returns can never be guaranteed.
If you are worried about the prospect of the investments made by life assurance companies into stocks and shares not growing sufficiently, then take care with endowment and ISA mortgages. There are no real differences between the types of policy when moving house. Don't be taken in by claims to the contrary. Adjusting mortgage arrangements when you move house may involve extra costs whichever repayment method you are using.
Take care whenever moving house that, if possible, you do not give up your insurance policies. In particular, giving up a life insurance endowment policy can be a very poor decision. If endowment mortgages are given up in the early years of the term, there may be surrender penalties.
You may not get back the full value of the sums invested on your behalf. Be cautious of endowment mortgages if you think that your personal circumstances may change in ways that could necessitate early surrender. The impact of changes in personal circumstances can, of course, be minimised if a prudent loan is taken out in the first instance. Choosing between companies Once you have decided on the type of mortgage you want, compare all the different lenders and
choose the best for you. With repayment mortgages the main element of competition is the interest rate charged. But with a variable-rate mortgage take care that you choose a lender who you think will have competitive rates for the full 20 or 25 years. Do not get caught out by special offers or loans with temporarily cheap rates. It is worthwhile looking at the costs, if any, of switching mortgage lenders. Sometimes mortgage
lenders require penalty interest payments for paying off the loan, which will be necessary if you want to switch. Take care also if mortgage offers are conditional on taking out other services, such as home buildings insurance or mortgage payment protection. What appears to be a good deal may be much less so once these extra costs are added in. With endowments and ISAs, a key factor in your choice should be the charges levied by the mortgage
lender on managing your investment. These charges differ considerably between lenders. Do not be impressed by the claim that high charges go hand in hand with better investment performance. Past investment performance is not a reliable guide to the future. While investment performance will affect your returns considerably, no-one can predict accurately which company will perform best over the next 25 years.
You should also take account of projected early surrender values in case you have to stop the mortgage. Take care that you fully understand the charges and surrender policies of the lender if you want to take out an endowment or ISA mortgage. Mortgage lenders may also try to sell you other products like house insurance, mortgage payment protection or health policies to protect you against serious illness. Some mortgage offers are
dependent on your buying these additional products. Don't rush into such packages. Look at the extras on their merits. If you decide you want a particular form of protection, check whether you could buy it more cheaply elsewhere. Finally, note that there is a voluntary code of practice, called The Mortgage Code, which governs how mortgage lenders work and deal with customers. This includes mortgage brokers. If you have a
problem with a lender or a broker ask for a copy of the code. It will outline how to take any complaint further. The Banking Ombudsman, the Building Society Ombudsman or the Council of Mortgage Lenders Arbitration Scheme may be in a position to assist in resolving certain complaints
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