The mortgage market can be a daunting place for potential buyers, especially right now. But armed with a little knowledge, they can soon identify a product that best suits them.
Buying a home is the biggest financial transaction most people carry out during their lives and, unsurprisingly, given the mindboggling sums of money involved, the whole process is fraught with stress.
Not only do buyers have the headache of finding the perfect property, they then have to negotiate their way through the mortgage maze - no easy feat for those who don’t know their SVRs from their LTVs or their trackers from their offsets!
An already stressful situation has been made significantly worse by the current economy, which has severely restricted the choice of mortgages available, particularly to first-time buyers. But there is good news. Interest rates are currently at a record low and there are more deals to get your hands on.
Where to start?
The first thing a potential buyer should do is decide what type of mortgage to opt for. There are two main types, fixed rate and variable rate.
Fixed Rate Mortgages
Under fixed rate, the interest rate the borrower pays stays the same during the term of the deal, typically two, three or five years, although longer terms may be available for 10 or even 25 years.
At the end of the fixed period you can move your mortgage to a better deal, but watch out for ‘lock-in’ clauses that charge an Early Repayment Charge (ERCs) to escape the deal. ERCs usually last the length of the fixed term but some last longer. E.g. a two-year fixed rate could have a four-year ERC. This means that you’ll be charged for transferring your mortgage to another company at any time in the first four years, including the two year period after your fixed rate ends (known as the ‘overhang’ period).
Fixed rate mortgages usually have an arrangement fee, however, some mortgage deals will pay this for you.
Variable Rate Mortgages
By contrast, a variable rate mortgage moves up and down as the Bank of England base rate changes. The main type is a tracker deal, whose rate changes automatically to match the base rate.
Variable rate deals can seem like a good idea when interest rates are falling, but it’s important borrowers consider how affordable the loan would be if interest rates went up.
Most trackers for new borrowers currently charge a margin of around 2% above the base rate, which is fine when rates stand at, say, 1%, but can be a bit scary if they rise to 5%, meaning you’re paying 7% interest – which could be a great big chunk of money to pay each month.
Standard Variable Rate Mortgages
There are also standard variable rate (SVR) mortgages, where the lender decides how much of an increase or decrease it will pass on to borrowers, although the majority of these deals are no longer available to new customers.
Discount Mortgages
Discount mortgages are variable rate deals that tend to track either the base rate or the lender’s SVR at a set level.
Offset Mortgages
Borrowers could also decide to opt for an offset mortgage, under which they agree to forego returns on their savings in exchange for their deposits being offset against their mortgage. This reduces the amount of interest they pay on it and ultimately shortens the mortgage term.
Deal Period
Most deals last a short period, generally between two and five years, after which, borrowers revert to their lender’s SVR unless they remortgage on to a new loan.
However, some deals are available for the entire mortgage period, such as lifetime trackers and 25-year fixed rate loans. So if you opt for a longer term deal it’s worth finding out the redemption penalty if it was repaid early, or whether it was portable, meaning if you move home, you could take the mortgage with you.
Drop Lock Option
If your brain is about to collapse from an information overload and you can see the pros and cons of both, you may also want to look into a tracker deal with a ‘drop-lock’ option, which enables people to switch to a fixed rate deal with the same lender, without having to pay any redemption penalties. This means borrowers can track interest rates down, swapping to the security of a fixed rate deal when they think they’ve hit the bottom of the cycle.
Repayment Period
Mortgages are traditionally repaid over a 25 year period, although people can opt for a shorter term if they want, while some lenders will lend over a 30 year period to make repayments more affordable.
Lenders will typically advance around 3.25 times a single buyer’s salary or 2.75 times a couple’s, although many are increasingly looking at the affordability of monthly repayments when deciding how much to lend.
Credit Crunch Lending Problems
The key problem facing first-time buyers at the moment is the lack of choice. A combination of the credit crunch, which has restricted the funds lenders have at their disposal, and falling house prices, has left groups reluctant to offer mortgages to people who do not have hefty deposits (sometimes as high as 40%) to put down.
There are now just a few lenders who have deals for people with only a 5% deposit, compared with more than 1000 different mortgages before the credit crunch first struck.
The shortage of deals for people wanting to borrow a high proportion of their property’s value, known as the loan to value ratio or LTV, shows the importance of savings for a deposit.
Rates for people who have only 5% to put down start at around 7%, assuming there's a mortgage available for them at all, but people who manage to save 20% of their home’s value can get deals at half this level.
What next?
Having selected a mortgage, buyers then need to apply for it. After contacting the lender they will be given a Key Facts Illustration which will set out the main features of a mortgage, as well as giving a personalised quote on monthly repayments and showing how much the loan would cost if rates were higher.
If the buyer decides to go ahead, they will make a formal application at this stage, and usually pay some or all of the application fee.
Application fees have been increasing during the past year, and for a good deal they are often around £1,000, although they can be as much as 2.5% of the sum being borrowed. Some lenders will allow this fee to be added to the mortgage, but interest will then be charged on it.
And finally…
Once the application has been processed, don’t expect to receive the money directly. While it would be nice to check your current account balance and see a six figure sum, in reality, mortgage lenders almost always transfer the funds directly to the solicitor handling the purchase on your behalf.
