Facts & Figures arranges mortgages on behalf of its clients and those of a number of estate agents in London and the South East of England. A mortgage is a significant commitment that may account for a large part of disposable income over a number of years. It is therefore important that borrowers carefully check their budgets to ensure that payments and terms are acceptable and that adequate insurances are in place (see below).
In broad terms borrowers may opt for a variable or a fixed rate of interest. Variable interest rates fluctuate according to market conditions and were as high as 15.5% as recently as 1990, only falling below 8% at the beginning of 1994. A rate of c 3.5% seems likely for the foreseeable future – although there may be fluctuations around these numbers.
Fixed rates give budgetary certainty for the fixed rate period, typically 2, 3 or 5 years and are particularly attractive for those on a tight budgets or when rates look set to rise. However, when rates look set to fall, fixed rates can tie borrowers in to paying more than they need to for a long period. Fixed rates can be expensive to get out of mid-term!
Fixed rates normally revert to the lender’s standard variable rate at the end of the fixed rate term. If you have any queries on whether fixed or variable rate is best for you, remember to ask us for the Facts & Figures.
Broadly speaking the choice of repayment vehicles is between:
- A repayment mortgage which can be likened to a hire purchase agreement, or,
- An interest only loan coupled with an investment contract to repay the capital at the end of term which can be likened to an overdraft to be repaid from the proceeds of an investment.
If interest rates remain unchanged and the borrower stays in the same house for the duration of the mortgage a repayment mortgage provides certainty of repayment. However, housing statistics seem to indicate that most people tend to move every 5 years or thereabouts. Monthly repayments to lenders under repayment mortgages are split between capital and interest with mainly interest being paid in the early years of the loan – when most of the money is outstanding; this is particularly true in the crucial first 5 years when hardly any capital is paid off. This is why many older people still have mortgages outstanding as in their early years they may have moved house several times – either to climb the property ladder or for work related reasons. With each move came a new repayment mortgage, often for a further 25 years. Meaning that on a series of 3, 25 year mortgages effected at 5 yearly intervals interest could be payable for 35 years overall.
Interest Only / Investment
Were largely discredited as a result of the endowment scandal. Most people now tend towards the certainty of a repayment mortgage
An interest only mortgage is usually linked with either ISA, low cost endowment policy, or a pension. Each of the three is dealt with under separate sub-sections below, but broadly speaking all the vehicles work on a similar basis.
The borrower effects a mortgage over a term, say 25 years, and repays interest only to the lender.
The borrower then effects a parallel investment contract, targeted to repay the capital at the end of the term.
The initial cost of the investment vehicle will be dependent upon the growth rate assumed. The higher the growth rate assumed, the lower the premium. Conversely the lower the growth rate assumed the higher the premium required.
The principle advantage of any type of investment mortgage is that however often one moves, the original amount of mortgage should be repaid at the end of term, subject to the performance of the investment plan. Obviously as with all investments progress should be monitored regularly to ensure that your objectives are being met.
Individual Savings Accounts provide a tax free investment vehicle that can be run along side an interest only mortgage. However, separate life assurance, health assurance and critical illness needs to be arranged alongside the investment. This can become both complicated and expensive.
Low Cost Endowment (LCE)
These plans offer a packaged product designed to repay a mortgage at the end of a specified term irrespective of how often a client moves and also on death, or if critical illness cover was added to the plan also on diagnosis of an insured critical illness. However many plans were sold on the assumption that 7% growth rates would be achieved and this has not been born out in practice. LCE is now largely discredited as a mortgage repayment vehicle, but many people have kept them on as savings plans.
Let’s face it we are all going to retire sometime, and most of us – unless we are independently wealthy – will need some kind of pension in retirement. Most company pension plans and all personal pension and retirement annuity contracts (but not contracted out personal pensions) will allow one to take a proportion of the accumulated pension fund on retirement as a tax free lump sum. For those with personal pensions this figure is 25% of the value of the fund. Therefore if retirement is not too far away (much over 25 years) you are a tax payer – and preferably a higher rate tax payer, and your pension fund in total is likely to be four times the amount of your mortgage, pension linking could well be worth considering. However, for most people the total cost — pension plan plus interest only —usually works out more expensive than other types of mortgage repayment. But you could get a “free” pension!
For further information on pension mortgages please contact Facts & Figures Financial Planning Limited.
Insurance It will normally be a condition of your mortgage that you put buildings insurance in place and that the lender’s interest is noted in the policy. It is wise to insure your household contents. If you have any dependents life insurance is essential. We usually recommend cover for all borrowers.
Critical illness insurance pays out a lump sum benefit on diagnosis of an insured critical illness and while many regard this as an extra we’d say it was also essential.
It is also wise to insure mortgage payments against loss of income.
Permanent Health Insurance which pays a monthly income on inability to work through illness or injury until recovery, death or retirement after an initial deferred period, or,
Accident and sickness insurance which is sometimes available with redundancy cover. This pays an income more quickly but for a limited period, typically 2 years. It is usually cheaper than PHI.
Talk to us for the Facts & Figures, but remember always take professional advice and check that cover meets your needs.