It's session number 18, and we’re going to be talking about Mortgages. It’s the one type of debt most of us need to get into, and is without doubt the biggest loan most of us will ever take out. For this reasons alone it’s a serious undertaking, so as ever, I’ll give you everything you need to know and everything you need to do to get it right.
Worth mentioning that the topic for this session came from a suggestion by Twitter user @buttaznang. If you have a particular subject you want me to cover here on the MM podcast, then just drop me a line, either hit me up on Twitter @meaningfulmoney, or email pete@meaningfulmoney.tv
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This week’s reviews
No iTunes reviews as such, but got this email from Matt Edwards:
Good morning,
Thanks for doing the podcast, really good coverage and useful tips. Just a thought for a future podcast – could you look at tax, given that this is how most of us ‘lose’ quite a bit of money.
Thanks, please keep it up,
Cheers, Matt. I intend to keep it up. That’s a great idea for a session, and that will be next time, session 19, so stay tuned. In the meantime, please click here to leave me a review on iTunes
News
On Thursday, stock markets had a real boost, rising the most in a long time, over 3% in a day. The new Bank of England Governor Mark Carney, who only started work on Monday commented (paraphrased) that the economy is still likely to struggle for some time and so interest rates are likely to stay low for longer than some had thought. Markets shot up on the news, as it looks like the benign financial environment will continue for some time.
Benign for who, though? Well, if you have a mortgage, we’re in the boom years. Interest rates have never been this low, so try to take advantage of this while you can by overpaying your mortgage.
It’s no fun for savers though, who are ‘losing money safely’ through inflation by keeping money in the bank at low interest rates.
But talking of mortgages and interest rates, let’s dive in to the meat of today’s session:
Introduction
I’m sure you don’t need me to tell you that taking out a mortgage to buy a house is a big deal. We’re talking about borrowing, in many cases, six-figure sums of money. And over a very long time, like 25 years or more. It’s a life-changing decision, so it’s very important that you are armed with the right information to enable you to make a good decision.
A mortgage is a good debt. You may remember from last time that we talked about the key difference between good and bad debt. It’s not just about the interest rate and the terms and conditions, it’s about whether the thing you are buying will go up in value.
Property doesn’t always go up in value; it can go down as well. Many factors might influence this. A huge housing development being built on the lovely rural view from your back window will likely affect the value of your house. The economic problems of the last few years have impacted house prices too – less lending by banks means fewer people buying houses, which pushes down prices – supply and demand.
But generally speaking, over the longer term, you can expect your house to increase in value. As you are paying off your mortgage at the same time, this is good news for your wealth.
So, let's deal with everything you need to know about taking out a mortgage
Everything you need to KNOW
1 – How much can you borrow?
This depends on a few factors:
- Value of the property
- Your income and other debts
- Your credit score
Let’s look at these in turn.
Value of the property
Usually, you can’t borrow the full value of your house, but instead, a percentage of it. Now, back in the heady days before the credit crisis of 2007 onwards, it was possible to borrow the full price of your house, and even more. You could borrow money on top of that to furnish the place, or consolidate other debts, but those days are gone, and this is a good thing. We are now back in a more normal environment.
You should expect to have to place a deposit on a house, usually at least 5% of its value, but more likely 10 or 15% these days. The difference is then made up with a mortgage. The part of the house value which is not mortgaged is called your equity (one of those words that means a few different things, e.g. Shares). Equity means ownership, really.
The greater the level of equity, the lower the risk of borrowing the money for both you and the lender. If you cannot make the payments on a mortgage, you will eventually be repossessed – the house will be taken from you by a court order and handed to the lender. A mortgage is secured on the property, so it is effectively owned by the lender until the last penny is paid off. If you are repossessed, the lender will sell the property and try to recoup their money which they have loaned to you.
With a decent amount of equity, it is likely that they will sell the house for enough to pay off the loan plus all their costs. This means there is less risk to them in lending you the money in the first place. In turn, this means you will probably get a better interest rate.
Your income and other debts
When working out how much they are prepared to lend to you, banks and building societies will take your income as a starting point and then apply a multiplier. For example they may be prepared to lend four or five times your salary. If you are buying a house jointly with a partner, they may offer four times the combined income, or maybe five times one income plus one times the other.
e.g one salary is £40,000 and the other is £10,000
Four times combined income: 40k + 10k is 50k, x 4 = 200k
5 + 1 arrangement: 5 x 40k is 200k, + 10k = 210k
Once they have this figure, they will usually deduct any other borrowing you may have. So if you have £10,000 outstanding on a car loan, they will reduce the total they will lend you by that amount. Each lender's multiples are different, and they may also use affordability as a guide. They’ll look at your net monthly income and see what proportion your mortgage payment will be.
Your credit score
When you apply for a mortgage, you give the potential lender your permission to do some digging on your financial situation. Obviously you must disclose your income and debts correctly. You will have to provide payslips to prove your income, for example.
Your answers to the questions on the application will be scored on some black-box criteria which are unique to each lender. So you would get a better score if you have been with your current employer for ten years rather than just one year, for example. If you have missed or been late making a payment on a previous loan, this would score badly.
All the scores are added up and the better the score the more likely you are to be offered a loan and you’ll get a better interest rate too.
The lender will also conduct a credit check to look at your history of borrowing money. They can see every loan you’ve ever had, and every payment you’ve ever made, or not made.
All this info will determine your creditworthiness. There’s a good summary on MoneySavingsExpert here.
It is worth checking your own credit file once in a while, and definitely before a big financial decision like taking out a mortgage. You can do this by going to either Experian or Equifax
2 – Interest rate behaviours
Assuming you are able to borrow the money, you need to know about how your repayments will work over the next 25 years or so.
Each payment you make will be made up of interest and capital, so you will pay a little bit off the loan each month, and you are guaranteed to pay off your mortgage at the end of the term, as long as you make your payments on time each month. If you have an interest-only mortgage you will have to save up to pay off your mortgage separately, as your mortgage payments only pay off the interest each month. These are much harder to get these days than they used to be.
In the early years, you aren’t paying off much capital; it’s mostly interest, but the balance switches more to interest in the latter years.
The amount of your monthly payment is determined by the interest rate. All lenders have a Standard Variable Rate that is their baseline rate. As the name suggests this is variable, so if interest rates are changed by the Bank of England, or if market forces suggest a change, then the interest rate you are paying for your mortgage will change too, and go either up (you pay more) or down (you pay less).
Most lenders offer deals to new borrowers, and these deals are usually expressed in terms of the interest rate, for example:
- Discounted Rate – You get so much off the SVR for a certain period of time, e.g. SVR minus 1.5% for two years
- Fixed Rate – The interest rate is fixed for a period of time, no matter what wider interest rates do in the mean time. These are useful if you think interest rates are going to rise in the near future
- Capped Rate – The interest rate you pay can rise, but not above a certain limit This means you will know the maximum you will be charged for the duration of the deal.
Another option is called offsetting, sometimes called flexible, or current account mortgages. These are usually offered by lenders who also offer normal everyday banking like current and savings accounts. The idea is that if you have a balance in a linked bank account, and a mortgage with the same bank, they will only charge you on the difference between the two. So if you owe £200,000 on your mortgage, but have £50,000 in a bank account, interest will only be charged on £150,000 of your mortgage. Note that you won’t receive any interest on the money in the bank.
These are called flexible mortgages because they allow you to pay them down, then borrow back very easily if necessary. They basically act as a giant overdraft you can dip in and out of.
One note on interest rates. You need to be happy that you can still afford to pay the mortgage even if interest rates increase. Rates are at record lows at the moment but they won’t stay that way forever. Find out what the monthly payment will be if the interest rate doubles – can you still afford to eat?
3 – The house-buying process
It is worth understanding the process of buying a house, so you’re prepared for what is a pretty tense and drawn-out process – not much fun to go through, but totally worth it in the end.
Let’s say you have found the house of your dreams. You need to make an offer which will ether be accepted or rejected by the vendor (seller) of the property. When you come to a deal, you will need to do two things:
- Instruct a solicitor
- Apply for a mortgage
The solicitor will do all the legal work called conveyancing, which means transferring the ownership of a property from one person to another. This includes searches of the Land Registry and all sorts of other technicalities. The solicitor will also handle the financial transaction. Your mortgage money will be sent to them, and they will forward it to the people you are buying from.
When you have applied for your mortgage, the lender will check two things out:
- They will check that the house is suitable security for the loan. Is it well made? Is it built over a mine shaft? Has it been valued correctly? They will insist on a surveyor visiting the property and making lots of checks to make sure the house they are lending money on is a good bet for them as well as you.
- At the same time they will be conducting the credit checks on you and making sure you can afford the loan. They will likely write to your employer for reassurance that your income is stated correctly
Once they are happy with both you and the house, they will issue a mortgage offer. This is the final agreement that the loan is approved and means the solicitor can request the money from the lender in order to make the purchase happen.
Once all this is in place, you can exchange contracts between your solicitor and your vendor’s solicitor. Only now is the transaction binding (at least in England and Wales this is true – it is different in Scotland). No-one can back out now without paying major compensation to the other party. A date is set for completion, where the money changes hands, and you get the keys to your new home.
Obviously if you are moving house, your solicitor will have to do a conveyance on your property too, and the sale of that and purchase of your new one will usually have to be synchronised. This is sometimes tricky and you can often end up with a ‘chain’ of sales and purchases, any one of which can fall through and break the chain.
Ok, so we’ve looked at how much you may be able to borrow, how the interest rate will work and how the house-buying process works. If I haven’t put you off entirely (I hope not), what do you need to do to ensure you do things right when you take out a mortgage?
Everything you need to DO
1 – Work out your budget
Owning a house is not just about making the mortgage payments. There are utility bills like gas, electricity, phone/internet, plus council tax to pay. If this is your first time owning a house, ask someone how much these are likely to be. The best people to ask are the people you are buying from.
Remember to calculate what your mortgage payment would be if interest rates doubled. Can you still afford to pay it then? If two of you are buying a house, what of one of you loses your job and can’t work? Could you tighten your belts and still afford to pay the mortgage?
You don’t ever want to get behind on your mortgage, so you must do your sums before taking one on. Session 3 is all about how to budget, and there’s a budget planner there to help you.
2 – Search the mortgage market, use a broker if necessary
There are currently many thousands of possible mortgage deals available from hundreds of different lenders. Needless to say, the ones available on the high street may not be the best one for you.
There are plenty of comparison sites out there to help you, just be sure that you understand all the different options before you go searching.
A mortgage broker may be a good bet. A good broker will have placed business with many different lenders and know the idiosyncrasies of each one. He/she may have good relationships with certain lenders and be able to get better terms than you would on your own. Most importantly, a good broker will get to know you and your circumstances and will have all the tools available to search the markets for the best deal. Better still, they will probably have an instinctive sense as to where the mortgage should be placed for a speedy offer.
Expect to pay several hundred pounds for the services of a decent broker, though this may be offset by commission, called a procuration fee, that the broker will get from the lender they place the deal with. Go to unbiased.co.uk to find a mortgage broker near you.
3 – Take out protection to cover the mortgage
A loan of this size should be protected against the worst. You probably know this, but if you die, the mortgage company doesn’t just write off the loan with a big sigh. No, they will come after those left behind and demand payment. A joint mortgage becomes the sole responsibility of the surviving partner of one you dies before it is paid off. You should take out life insurance to make sure that if the worst happens, the loan can be paid off once and for all with the proceeds from the policy.
But what if you fall ill, seriously ill? What if it isn’t serious, but can’t work for a prolonged period of time? Could you still pay your mortgage then?
Critical Illness will pay a lump sum if you are diagnosed with something nasty like cancer or a heart attack. Income Protection insurance will pay you an income to replace the income from your job if you can’t work due to illness or accident.
I go into much more detail on these in podcast session 7. You might also want to check out video episode 265 which asks (and answers) the question: How much life assurance do you need?
4 – Consider alternatives to mortgages and house buying
We have a (healthy) obsession with home ownership in the country, which isn’t present in many others, though much of Europe is catching up. In many other parts of the world it is normal to rent all your life and never to buy a place of your own. I’ve heard renting called ‘dead money’ more times than I can count, because you’re not building up an asset for yourself, instead you’re paying off your landlord’s mortgage!
But don’t discount renting out of hand. It’s easier to get out of if money becomes tight – you can walk away more easily.
If you don’t think you can find the sort of deposit you need these days (Bank of Mum & Dad?) you could consider shared ownership where you take out a mortgage for part of the property and rent the rest from a landlord. There’s not time to go into much detail, but Santander have a good guide, until I get round to filming a video episode about it!
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As you can tell, there’s a lot to the process of getting a mortgage. I hope I haven’t put you off! Owning a house is a great feeling, but I’m sure (I don’t know this yet) that owning a house with a mortgage paid off is even better.
Outro
That's it for this session of the MM podcast, I hope that was helpful. Did I miss anything that you wanted to hear about? Any other questions? Please leave any comments or questions below:
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I hope you enjoyed this session Next time we'll be talking about Tax.
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Thanks for listening – I'll talk to you next time
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