Mortgages are things you can love and hate
Mortgages can help you buy the home of your dreams, but they can devilishly eat into your income over your lifetime – income which you could have spent on your family, having a better standard of living and making better provision for your retirement.
In this short article I explain how mortgage lenders decide how much to lend and tips for reducing the cost of your mortgage over your lifetime.
Who needs a mortgage?!
Unless you’ve been born into money, have seriously generous parents or have saved religiously for year, when you come to buy your first home, the odds are that you’ll need a mortgage. Even if you’re planning to move to your next home, it’s likely you’ll need to review and potentially replace your existing mortgage although most lenders allow you to move your mortgage to another property.
A mortgage is the one financial product that most people will need but at the same time hate it. After all, why would you want to take money out of your pay cheque each month to pay back money to a bank plus interest!
So, the big questions are how do you borrow what we need and how do we pay off the debt as quickly as possible, and save as much interest as possible?
Let’s take the first big question – ‘how do I borrow what I need’
Lenders are very careful to ensure that the people they lend to will pay the mortgage for its full term. This has become even more important as mortgage lenders how now tightened up their lending policy over the last few years, following criticism from the industry watchdog. This means they need to be comfortable you have a reliable and steady flow of income to at least pay the interest on the loan. If you’re taking an interest-only mortgage, where you are deferring paying off the whole mortgage debt, lenders will also want some assurance that you have some form of strategy to eventually pay off this debt. Even if this means selling the house at the end of the term.
So, if you’re employed, lenders will want to know that you’re in a secure job without any restrictions, such as being in any probationary period. They may even ask your employer for a reference, although this is now fairly uncommon and will normally ask to see several months’ payslips or your latest P60.
If you’re self-employed, lenders take an even keener interest in your income. Where you’re borrowing a high percentage of the property purchase and you operate as a limited company, lenders may ask to see two to three years of audited accounts or at least a reference from your accountant. If you are Schedule D self-employed, lenders may ask for an accountant’s reference, bank statements etc.
A lender will also want to understand your financial behaviour.
This means understanding how you manage debt, such as making repayments on time on credit cards. A lender will examine your credit file very carefully and may accept or decline your application purely on this record. Most lenders will use a ‘credit score’ as its benchmark to decide whether to take the application further. The score can be affected by having a poor credit history or even having no credit history; not being experienced in managing debt can limit your chances of securing a mortgages, or at least with a high percentage loan. Very often applications with low credit scores will automatically be declined, so it’s really important that you check your credit file before making a mortgage application. Do bear in mind that having past credit problems does not necessarily mean that you cannot get a mortgage.
How much will they lend?
If your income is secure and you have an acceptable credit record, the next question is how much the lender will lend you. Lenders tend to have a very standardised affordability check which works by multiplying your income by a certain factor, which may be different depending on your occupation and method of mortgage repayment. The lender also wants to ensure that your monthly repayment won’t exceed a percentage of your total disposable income. This is normally about a third but can change if interest rates are expected to change significantly. This basis of an affordability check is normally shown on the lender’s website, but you should also ask your mortgage adviser to let you know how much the lender is likely to lend before you make an application.
The way mortgages advisers will normally approach your enquiry, is to find out a lot about you that would be of interest to a lender. They will then effectively ‘match’ you with a suitable mortgage. This will mean looking at the lenders’ mortgage products, their terms and conditions, affordability calculations and interest charges for its different mortgage products. It’s a bit like finding a needle in a haystack and it can take time. You also need to be realistic – the worse your credit file and the more you want to borrow, the more limited the choice and the more restrictive the terms and conditions and interest rate charges. But a good mortgage adviser is worth their weight on gold and we’d strongly encourage you to arrange your mortgage in principle with your mortgage adviser before looking for a property. This needs some thought as I generally will not arrange an Agreement or Decision in Principle at this stage.
Let’s look at the second question – how do I pay off the debt as quickly as possible and save as much interest as possible?
Repaying your mortgage debt may seem unimportant when its obscured by the thought of owning your own home or next home. But looking at the amount of interest charged over the life of your mortgage is eye watering and not for the faint hearted! Let’s take a simple example. If you borrowed £300,000 over 25 years at an interest rate of 0.5%, your total interest charge would amount to around £37,500. This of course would b paid out of net income. If you are a basic rate tax payer, that’s around £46,875 of income you’d need to earn simply to repay the interest on your mortgage, before you repay any of the debt. This does not make it clear that the interest amount is over the whole 25 years and that interest rates will be a lot higher than 0.5%. Your mortgage monthly payment will be a significant percentage of your monthly net income. At Grosvenor Wealth we will ensure that the your mortgage repayments are as efficient as possible.
The two key things to remember about how to ensure your mortgage doesn’t eat its way through your life’s income is the larger it is and the longer you hold it, the more interest you pay overall. There are a few ways of taking back control and save huge amounts of income.
Firstly, pay a little extra back every month. Even the cost of a takeaway makes a difference as it will reduce the balance of your mortgage. This has two advantages – it means the lender can’t charge you interest on that repaid debt ever again; secondly, if you have a repayment mortgage, you’ll paying off your mortgage sooner.
Secondly, use savings held in your bank to offset your mortgage. This means you won’t earn on your savings (potentially losing peanuts) but you won’t pay interest on your mortgage for the amount saved, a much bigger rate of interest!
Some (Most) lenders these days will offer offset mortgages, although these are normally only available for variable rate mortgages – not fixed rate mortgages. These types of mortgages also provide the added benefit of still giving you access to your savings. Naturally, this will save you a lot of mortgage interest, but to make the most of an offset mortgage you should look to continue to pay your normal monthly mortgage payment – using the saving to pay off capital which in itself will reduce your overall interest charge (if you’re on a capital and interest mortgage), plus pay off your mortgage earlier.
Most other schemes allow you to overpay by up to 10% of the outstanding mortgage per year without penalty – fixed rates as well as variable.
Getting a mortgage can be a tricky business. There are many different criteria and requirements which are as varied as the number of Lenders offering mortgages. We can look at the whole market to get the mortgage which suits you best. That’s how we can help. Please give us a ring.
Do not forget. Getting a mortgage or doing a remortgage or arranging a Product Transfer is only the start. At Grosvenor Wealth Management, we will be with you every step of the way until the mortgage is paid off. We will advise you, report to you and remind you when action needs to be taken.
- You should not over-commit yourself in terms of your mortgage repayments and other expenses. You will still need to keep up repayments if your income reduces due to sickness, accident, unemployment etc. Your home may be repossessed if you do not keep up your repayments.
- You should not enter into any binding agreement or commit yourself to any financial undertakings until you have received, read and understood a satisfactory offer letter.
- Your mortgage application may not be accepted by the recommended lender if you do not meet their affordability criteria.
- You cannot cancel a mortgage once it has completed.
- Your monthly repayments could be considerably different should interest rates change.
- Past levels of interest rates are no guarantee of future rates.
- The value of your property is based on opinion rather than fact. If the value of your property falls, the loan amount may be greater than the property’s value, and will still need to be repaid in full.
- If details are given incorrectly, withheld, or are false in any way, the lender will almost certainly reject your application. This will make it much harder to apply to another lender.