Choosing a Mortgage

Introduction

A mortgage is a loan that is taken out to pay for a property, and for which the property acts as security. The loan is composed of the capital sum borrowed and the interest the lender charges on it. If the borrower (or mortgagor) fails to repay the loan as agreed, the lender (or mortgagee) can sell the property, to recover the amount owed.

It sounds simple enough. However, the mortgage market is becoming ever more complicated, with a bewildering variety of different types of loan now available, and new ones constantly arriving on the scene. The good news is that such hot competition has resulted in the availability of some excellent deals.

This article explores some of the factors you should take into account when choosing a mortgage. It cannot be comprehensive, nor is it a substitute for expert professional advice.

Laying the foundations

Before you can compare individual mortgages, you’ll need to decide the type of mortgage you want, how much you can afford to borrow, and over what period to borrow it.

Type of mortgage

Because your loan will probably be repaid over a number of years, during which time your circumstances may well change, choosing the best kind of mortgage can be difficult.

Types of Mortgage explains some of the options available. Before making any decision, seek advice from an impartial source, such as an Independent Financial Adviser (IFA).

Amount of loan

A lender will want to be confident that you can afford the repayments, and that the property you are buying is worth enough to cover the loan should you default.

How much you can borrow will, therefore, depend on:

• How much you earn

For a single person, a loan of up to 3.5 times annual earnings was traditionally the norm, but 4 times multiples are not unusual nowadays, and even 5 times multiples are not unheard of (among high earners).

For a couple, typical multiples are 2.5 times joint annual income, or 3–3.5 times the higher income.

Things in this area are changing rapidly. Some lenders now take into account potential future earnings as well as current ones.

Responsible lenders will seek proof of income. Standard requirements are:

o Employed: payslips and your last two years’ P60s. Lenders may also seek verification from your employer

o Self-employed: in most cases, three years’ worth of audited accounts. An official letter from your accountant will normally be acceptable if you have been in business for under three years

• The value of the property you are buying

Most mortgage providers will lend up to 75 per cent of a property’s value. Some will lend 95 per cent, or even 100+ per cent. This level of borrowing is, however, extremely risky (see Types of Mortgage).

• How much the lender calculates you can afford

Although you may be able to afford the repayments in theory, you may have other outgoings that would make you unable to do so in practice. Some lenders will ask you for details of other borrowings, and request copies of bills.

Term of loan

This can have a huge impact on the amount of interest you will pay. Although, because the monthly payments are higher, a shorter term may initially appear more expensive than a longer one, it will work out cheaper in the end, because less interest will be paid over the life of the loan.

A mortgage term can be as short as five years, but this is unusual, anything from 15 to 25 being the norm. Longer loans are available.

Traditionally, lenders insisted that a mortgage ended when the borrower reached 60–65. Some still do, but the situation is changing. Many are even prepared to grant loans (albeit generally shorter-term ones) to people who are already retired.

If you are buying a leasehold property, your lender may insist on a term that allows for a certain number of years to remain on the lease after the mortgage finishes.

Shopping around

You are now ready to start looking for the best deal. You can do this by pounding the pavements, by phone, or online.

Your main options are:

• Approach banks, building societies and other potential lenders direct

Bear in mind that each will only sell its own products (although, increasingly, these institutions are acting as multi-tied brokers – see below).

• Consult an IFA

Check qualifications and charges. Though advisers used to be paid via commission on the products they sold, fee-based charging systems, which offer protection from accusations of bias, are becoming more common.

• Use a mortgage broker

There are three types:

o Tied brokers – who can only offer you a mortgage with one particular lender

o Multi-tied brokers – who can provide mortgages from a number of different lenders

o Independent brokers – who can advise you on mortgages available from all lenders

Like IFAs, mortgage brokers are now regulated by the Financial Services Authority (FSA). They are obliged to recommend the best deal for clients’ individual circumstances, regardless of personal gain. As with IFAs, charging methods vary, so check. Brokers specialising in a particular field (for example, loans for the self-employed) are now common.

Making your mind up

When reviewing mortgage quotations, you should:

• Ensure you are comparing like with like. You can do this by getting each lender to quote for the same amount borrowed over the same term.

• Scrutinise the Annual Percentage Rate (APR). Unlike the Headline Interest Rate, this will reflect all the costs of the mortgage, including the application fee, lender’s valuation fee, legal fees, and so on.

• Be on the lookout for penalty clauses. To discourage you from switching to another lender, some mortgage companies impose financial penalties for paying off your mortgage before the end of the term.

The lower the interest rate, the higher the penalty is likely to be. Since you do not know what the future may hold, it is wise to stay as flexible as possible, so do not base your choice of mortgage solely on an attractive interest rate.

• Be realistic. Some lenders offer flexible mortgage arrangements, whereby borrowers have the option of varying the amount of their monthly instalments. They can thus pay more when they can afford to, or miss a payment in the event of temporary financial problems.

Such flexibility can be useful, but remember that, however you organise things, you will have to pay at some point. Unless you are confident of your self-discipline, this arrangement may not be the one for you.

A word of caution

It’s easy to get carried away when you’ve found the perfect property, but you should never be tempted to borrow more than you can afford – whatever someone is prepared to lend you. We’ve all heard of people whose over-optimism and lack of realism have resulted in appalling financial difficulties, including, in some cases, the loss of their home.