Riach Independent Financial Advisers Jargon

Mortgage Jargon & Tips

A mortgage is a sum of money borrowed from a bank or building society in order to purchase a property. The money is then paid back to the Lender over a fixed period of time together with accrued interest. There are many different types of mortgages and there will be one out there that best suits you


Mortgage Certificate
If the housing market is rising, and particularly if you are a first-time buyer, you should be absolutely clear about the type of mortgage you want before you start looking seriously at what to buy.
In a rising market sellers will be inundated with potential buyers, and will try to weed out the serious from the time-wasters. To give yourself a better chance of getting your dream property you should consider obtaining a Mortgage Certificate - this is a document from a lender which effectively says "we haven't actually lent any money to this person, but we would definitely be prepared to lend Łx." In other words, a Mortgage Certificate demonstrates to a seller that you are both seriously interested in their property, and have the financial means to buy it. On a more general note it is always a good idea to assemble the various documents you will need for a mortgage as soon as possible. These include three months of pay-slips, bank statements for the last three or six months, and proof of the size of deposit you are planning to put down.

Getting A Survey
Before they will lend you the money for a property the lender will do a survey to check its worth. There are major dangers for the lender in giving you more money than the property could be sold for. Incidentally, the lender will usually charge you a fee for doing the survey which is not refundable if you don't go ahead with the mortgage.

There are two important points about the lender's survey: it is not usually very comprehensive, and it only expresses an opinion about whether the property is worth the amount you are borrowing.

If you are putting down a substantial deposit then you should consider having your own survey done, to get an opinion on whether the house is worth the total amount you are paying for it rather than the amount you are borrowing.

In fact, although the expense is not trivial, it is always worth considering having your own comprehensive survey done anyway. Unless you already know a surveyor the easiest way to arrange this is to phone the Royal Institute of Chartered Surveyors and ask them for a list of surveyors in the area where you are buying the property.

Repayment vs. interest-only
In some ways, buying a property can be an excellent investment: unlike a pension scheme or an ISA you can live in it, there's no tax on any profits you make (on your main residence, at least), and it will provide days of harmless fun mowing the garden. The disadvantage, of course, is that most people need a mortgage to buy a property, and a mortgage is a debt - and usually a very substantial one. It typically lasts for 25 years, which can feel like forever, and the size of your monthly payments can go up (or down) quite dramatically depending on interest rates. Mortgages break the cardinal rule of financial planning that you should pay off your debts before thinking about saving. The other problem with mortgages is that they involve making a major financial decision which isn't easily reversible later: whether to take out a repayment or interest-only mortgage.

Capped, fixed, discount

Having decided between repayment and interest-only mortgages, you're then faced with a second decision. What sort of loan do you want?

The simplest is a variable rate. The rate of interest on your mortgage, and therefore your monthly payments, simply goes up and down according to whatever interest rates currently are in the economy at large. The only problem is that this variation can be very wide. If interest rates move from 5% to 15%, which has happened within the last ten years, your monthly payments triple.

Strangely, many borrowers don't like the prospect of this happening, and are therefore attracted by two sorts of guarantee which lenders offer: fixed and capped rates. A fixed rate mortgage is what it says: the interest rate is set at a certain level, and therefore so are your payments. A capped rate is slightly more complex: there is a maximum level above which your payments can't rise, but they can also fall if prevailing interest rates fall below the cap.

On a 25-year loan these guarantees are quite dangerous for lenders to make. They have major problems if prevailing interest rates are 15% but they have fixed or capped people's mortgages at only 5%. In fact, they would go out of business. Therefore, fixed and capped rates are only usually available for the first few years of a mortgage (up to 5 years), after which the mortgage switches to the normal variable rate.

The other short-term incentive which lenders offer is discounted rates. Your payments are variable, but you get a discount off the standard variable rate. Once again, this discount is only for a limited period.

These short-term incentives only make commercial sense for the lender if you stay with them beyond the point at which the incentive ends. Therefore, there are almost always stiff early-payment charges (redemption penalties) if you try to pay off a fixed, capped or discount mortgage before the incentive period ends.

If the range of products on offer were not already confusing enough, there are two other incentives which have become popular in recent years.

The first is "cashback", which is not fundamentally different to getting cashback at a supermarket. You take out a loan with a lender, and they give you not only the amount you are borrowing, but a bit more as well. This can be used for home improvements, furniture, a party etc. Ultimately, of course, you are paying for this cashback in one form or another. There's no such thing as a free lunch.

Finally, there are "flexible" mortgages, increasingly driven by new technology and its ability combine many different financial schemes in one place. In a flexible mortgage your mortgage loan is combined with other sorts of debt such as credit cards, and sometimes even with your current account. The idea is that the rate on a flexible mortgage may be slightly higher than the standard variable rate, but you benefit from lower rates on your credit cards and from earning interest on your current account.

How much you can borrow?
You can borrow as much as you like, as long as you can pay for it. How long is a piece of string? Most lenders use a fairly simple formula for determining how much they will lend you. If you are a sole applicant, they will usually lend you up to 3 or 3˝ times your salary. If you are making a joint application with your partner they will usually lend 2˝ times your combined salary. These figures may be reduced for people with a poor credit history, or increased if you are very wealthy. The other factor is the amount of deposit you are putting down. For first time buyers, lenders will usually let you borrow between 90% and 95% of the value of the property. If you are moving house or buying a second home you may well find that you have to put down a larger deposit, or pay a higher interest rate. Some lenders will even let you borrow more than a property is worth, but the interest rate will usually be "rather special". Buildings and Contents Insurance
Mortgage lenders, being kind and thoughtful people, will usually offer you buildings and/or contents insurance when you take out a loan. They may even insist that you take it.

If it is a condition of a loan that you take out this insurance from the lender themselves, rather than from any old third-party, check your sums. The lender will almost always be charging higher than average rates on the insurance policies to pay for special offers on the mortgage loan itself.

This is not to say that you should not take out buildings and contents insurance. The former is more or less a legal requirement, and the latter is at least a very good idea.

Buildings insurance covers damage to the fabric of your home, and the amount of cover you have should be at least enough to rebuild it from scratch. However, buildings insurance is the responsibility of whoever owns the freehold of a property, and therefore only usually applies when you are buying a house (rather than a flat). Owners of flats do not need buildings insurance themselves, but usually end up contributing to their freeholder's insurance by way of an annual service charge.

Contents insurance is, obviously, cover against loss, theft or damage to the contents of your home. The cost of cover is obviously determined by where you live, the value of your contents, and the security arrangements you have in place. Always make sure that you have installed all the window locks, burglar alarms etc. required by the terms of your policy. If your security arrangements are "inadequate", the insurers will refuse to pay out.

Life Cover

Unless you take out an endowment (interest-only) mortgage you will need to arrange separate life cover to pay off the mortgage if you die.

For an interest-only mortgage you need simple "level term assurance" - the amount you owe remains the same until the end of the mortgage, and therefore so does the cover you require. (As discussed earlier, you will also need to set up a repayment vehicle.)

On a repayment mortgage the amount you owe decreases over the mortgage term until the entire loan is paid off. Therefore, you need the slightly more specialised decreasing term assurance, otherwise known as "mortgage protection".
Types Of Mortgage

There are essentially two different types of mortgage:
Repayment only, (capital and interest mortgage)
Interest only, (ISA, pension or endowment mortgage)
Repayment only.

Your monthly repayments consist of repaying the capital amount borrowed together with accrued interest. On your mortgage statement, normally received annually, you will see that the amount borrowed decreases throughout the term.
ADVANTAGES
At the end of the term, you are safe in the knowledge that the total amount of the debt has been repaid.
Overpayments and lump sum payments into your mortgage account can be made reducing both the interest and capital amounts repayable.
Life assurance cover is not always necessary in taking out this type of mortgage.
DISADVANTAGES
There may be financial penalties for making lump sum/overpayments into your mortgage account. In the early years of a repayment mortgage the majority of the monthly repayment is interest rather than capital. For borrowers moving house regularly, this can result in little of the capital being paid off.
If you have no life assurance cover in place and die before the loan is repaid, the mortgage will still need to be repaid. This may result in the property having to be sold to repay the debt owed. Interest only. With this type of mortgage, only the interest is paid off with each mortgage payment. The borrower also takes out at the same time, an alternative ‘repayment vehicle’ (method of paying off the mortgage) such as an ISA, pension plan or endowment policy. More information about endowments (which in the 1980’s and 1990’s were extremely popular), ISAs and Pension plans are below. The most important fact about an interest only mortgage is that the monthly repayments do not repay any of the outstanding capital balance. As a consequence it is important that the payments are maintained into the repayment vehicle otherwise it will not be possible to pay off the mortgage at the end of the term.
Endowment ISA Plan Pension Endowment The most common type of interest only mortgage which also provides life assurance cover and a fixed payment for investment. The fixed payments are based on the amount of the loan together with the mortgage term and are designed so that, at maturity, the amount invested and earnings are sufficient to pay off the mortgage. Much maligned in the press because of the poorer investment growth rates achieved in a low inflationary environment this form of investment is less popular these days. Note there is no guarantee that, when the endowment matures and ‘pays out’, the balance will be sufficient to repay the mortgage. Nonetheless millions of borrowers have one or more endowment policy and as a rule of thumb these should not be cashed-in early and certainly not before seeking advice from a suitably qualified financial adviser. Customers cashing-in an endowment policy in the first few years after inception can receive less than the amount invested. Existing endowments can be used to support a new mortgage with any ‘additional lending’ over the value of the projected maturity balance being covered on a repayment basis or with an alternative repayment vehicle e.g. an ISA. It is also worth pointing out that historically the returns on endowment policies have been pretty good (provided they go full term). Endowments provide life assurance so that in the event of death the mortgage is paid off.
ISA
The Individual Savings Account (ISA) is a tax free method of saving. Using an ISA as a repayment vehicle is growing in popularity but due to the ISAs complexity it is only for the financially sophisticated or borrowers taking advice from a suitably qualified financial adviser.
Pension Plan
Life assurance cover is provided and monthly payments are made into a pension fund. When the benefits are eventually taken, the mortgage is repaid using tax-free cash from the remainder of the fund. The plan holder can then draw a pension from the balance of the fund. This product, which tends to be used by the self employed, is only for those taking advice from a suitably qualified financial adviser.
ADVANTAGES
If the proceeds of the plans exceed the amount required to repay the mortgage, then this is received as a cash lump sum by the borrower.
Some plans are tax-efficient.
DISADVANTAGES
If the proceeds of the repayment vehicle do not achieve the amount expected, then there will be a shortfall. The borrower remains liable for any shortfall on the mortgage hence the outstanding balance will need to be paid off from other resources. Regular checking of the policy fund itself by the borrower and the lender should minimise any risk. If the plan is not reaching its expected target, the borrower can increase payments into the policy or invest in another product to cover any anticipated shortfall.
Cashing in the plans early may result in financial penalties. These will be provided for in the initial agreement. In addition the lender has no way of tracking some of the more modern repayment vehicles, such as an ISA, which will result in some instances where a borrower lets an investment lapse forgetting or not realizing it is to be used to pay off the mortgage. This will result in situations where there is no method of paying off the mortgage and the lender will only become aware at the end of the mortgage term.
INTEREST RATES ON MORTGAGES

When you have chosen the right mortgage for you, whether it be a repayment or an interest only mortgage, you will need to consider the 4 main mortgage rate options available.
FIXED CAPPED DISCOUNT VARIABLE
Fixed Rate Mortgage.

The amount you repay the lender each month can be at a fixed interest rate for a certain period of time, regardless of the interest rate in the market place. It is common for lenders to offer rates fixed for a period of 2 to 5 years, but shorter and longer periods can be found in the market. At the end of the fixed rate (or ‘benefit’) period the rate will normally convert to the lenders Standard Variable Rate (SVR).

It is normal for lenders to charge up-front fees in the form of booking and/or arrangement fees. In addition lenders frequently apply an Early Repayment Charge (ERC) for fixed rate mortgages. This acts as a ‘lock-in’ making an often heavy charge for borrowers paying off their mortgage early. Watch out - the ERC can sometimes last longer than the fixed rate period e.g. a 3 year fixed rate with a 5 year ERC.
Capped Rate Mortgage.

A capped rate mortgage is very similar to a fixed except that if the variable rate drops below the capped rate, the borrower will make payments based on the lower variable rate. However should rates increase the payments will be ‘capped’ and will not rise over the capped rate. So as a rough ‘rule of thumb’ a capped rate is better to have than a fixed if all other factors are equal. Again, as with fixed rates, up-front charges and ‘lock-ins’ are common.
Discounted Rate Mortgage.

The Lender offers a discount on the Standard Variable Rate (SVR) for a specific period of time. For example, the variable rate may be 5% with a discount of 1.5%. The initial pay rate would therefore be 3.5%. If the variable rate rose to say, 6%, then the rate payable would rise to 4.5%. As the discount is linked to the standard variable rate, the borrowers payments will increase, if rates rise - so there is no certainty in budgeting. However should rates decrease the borrower will benefit from lower payments.

It is still possible to have up-front charges for discounted products and an Early Repayment Charge is common.

With discount mortgages borrowers need to watch out for ‘payment shock’. Some short term discount products offer a ‘deep discount’ e.g. 4% off for 1 year. In such circumstances the borrower will be facing a significant increase in their monthly mortgage payment at the end of the discount benefit period.
Variable Rate Mortgage

Borrowers paying the Standard Variable Rate will have their payments increase or decrease as the lender adjusts the rate in accordance with market conditions.
FEATURES AND OTHER BENEFITS OFFERED WITH MORTGAGES

There are other key features and benefits to be considered when determining the best mortgage for a prospective borrower.
FLEXIBLE / LIFESTYLE MORTGAGES CURRENT ACCOUNT MORTGAGE (CAM) CASHBACK FREE LEGALS OR CONTRIBUTION TOWARDS CONVEYANCING COSTS FREE VALUATION OR REFUND OF VALUATION FEE OTHER BENEFITS
Flexible / Lifestyle Mortgages

A Flexible or ‘lifestyle’ mortgage is designed to let you to make extra repayments when you have extra money, and to reduce or even skip payments when necessary. Borrowers will normally have to build up a reserve through overpayments before being allowed to underpay or skip payments. The main benefit of flexible mortgages is that many schemes are offered on a Daily or Monthly Interest Calculation basis (sometimes referred to as ‘daily rest’ or ‘monthly rest’). Until the arrival of flexible mortgages most, if not all, UK lenders were charging interest on an annual basis which meant that borrowers making over-payments were not getting the benefit straight away because it could be a year before the capital was reduced by the over-payment. Whereas, on a mortgage where the interest is being calculated on a daily basis, any over-payment reduces the mortgage balance immediately hence the borrower will be charged less interest from the next day. Without going into detail to explain this feature the up-shot is that over-paying the mortgage on a monthly or regular basis, even by a relatively small amount, will reduce your mortgage term by years (hence saving payments).

Many flexible mortgages come without any Early Repayment Charge so the borrower is not ‘locked-in’ to any particular lender. In addition the interest rate charged is often lower than the usual Standard Variable Rates charged by the other more ‘traditional’ mortgage lenders.

The flexible mortgage concept was imported from Australia so occasionally you may hear them referred to as ‘Aussie style mortgages’.
Current Account Mortgage

A flexible mortgage linked to a current account. These mortgages take the benefits of the flexible mortgage and use the funds held in the current account to offset the interest e.g. on a particular day a borrower has a mortgage balance of Ł50,000 and has Ł2,000 held in the current account. The customer is charged mortgage interest on Ł48,000 i.e. the mortgage balance minus the positive balance held in the current account.

Some of the newer entrants into this sector are also linking savings accounts, credit cards and personal loans into the mix.

For a borrower wanting one home for their finances this is an attractive option.
Cashback

The Lender, as an incentive, will offer a lump sum of cash once the mortgage has been taken out. The amount will vary from lender to lender and on the size of the mortgage. The amounts can range from a flat fee e.g. Ł200 to a percentage of the loan e.g. 3% of the loan.

Normally the cashback is offered as a package of benefits e.g. linked with a discount, but pure cashback products are not uncommon. Mortgages offering a 5 or even 6% cashback can be found which would mean a borrower taking a Ł70,000 mortgage would receive Ł4,200 on completion (at 6%).

As you would expect lenders apply an Early Repayment Charge with cashback mortgages. Typically a borrower will be locked-in for 5 to 7 years where a substantial cashback has been paid.
Free Legals or a Contribution Towards Conveyancing Costs

More common on products aimed at the remortgage market but a frequent product ‘enhancement’. To take advantage of the offer the mortgage applicant will normally need to use a firm of solicitors or licenced conveyancers nominated by the lender.
Free Valuation or Refund of Valuation

A free valuation requires no up-front payment from the mortgage applicant whereas a refund will only be made when and if the mortgage application completes. Hence an applicant paying for a valuation and then not proceeding due to, say, a poor valuation, will not have their valuation fee refunded.
Other Benefits

A whole range of other benefits can be applied to mortgages including the significant benefits of no Higher Lending Charge and no Early Repayment Charge. See below for more information about these features.
OTHER FEATURES / CONDITIONS AND CHARGES ASSOCIATED WITH MORTGAGES

Early Repayment Charge (sometimes referred to as a ‘redemption penalty’)

Given that the mortgage market is very competitive many mortgages are sold as ‘loss leaders’ i.e. the mortgage has to be held for a number of years before the lender breaks into profit. As a consequence lenders frequently ‘lock-in’ borrowers by applying Early Repayment Charges for those paying off the mortgage early. Charges can be significant e.g. 6 months interest or repayment of the amount of benefit received, be it cashback or reduced interest. The period an Early Repayment Charge applies can vary. Sometimes it will match the period of the discount/fix but often it can go beyond the benefit period e.g. a 5 year discount with a 7 year ERC. This is referred to as a ‘redemption overhang’.

On this subject see ‘No Redemption’ and ‘No Overhang’ below.
No Redemption

Selecting the ‘No redemption’ option means that the mortgage schemes on screen will allow you to repay the loan in full at any time without applying an Early Repayment Charge.

Most mortgage schemes, in return for offering you a lower initial rate, will require you to stay with that scheme at least for the period of the Discount, Fix or Cap, and often longer. If you wish to repay the loan in this time, or you remortgage with another lender, you will have to pay an Early Repayment Charge which can cost Łthousands (6 months interest is common) depending on the lender and scheme.

With ‘No Redemption’ mortgages you will not have to pay this redemption fee (although there may still be other costs such as sealing fees and legal fees.) As a consequence of not being ‘locked-in’, the rate offered on these schemes will usually not be as competitive as for mortgages with redemption penalties, making them most suitable for those who are likely to keep track of current rates and wish to remortgage quickly if they find a better rate, or those who may have to repay their loan in the first few years.
No Overhang
Selecting the ‘No overhang’ option means that the mortgage schemes on screen will allow you to repay the loan without penalty once the benefit period has ended i.e. the mortgage does have an Early Repayment Charge but it does not last longer than the fixed, capped or discount period. This means that a mortgage with, for example, a discount to 31st January 2006 will have a redemption charge to either the same date or a date prior to this. The Early Repayment Charge can represent a significant sum although the amount will differ between lenders and between products. With ‘No overhang’ mortgages you will only have to pay this redemption fee if you redeem the loan or remortgage whilst you are still subject to the scheme’s special rate. Once you have reverted to paying the lender’s Standard Variable Rate (SVR) you will be able to redeem the loan without penalty (although there may still be other costs such as sealing fees and legal fees.) As a consequence of not locking-in the borrower to the lender’s SVR, the rate offered on these schemes will usually not be as competitive as for rates with redemption overhangs, making them most suitable for those who wish to benefit from a lower initial rate without needing a very low initial rate, and who are likely to want to remortgage to another Discount, Fix or Cap once they are no longer benefiting from the initial rate.
Higher Lending Charge (sometimes referred to as a High Percentage Lending Fee)

For high Loan to Value (LTV) mortgages i.e. where the loan is not much less than the value of the property, it is common practice for the lender to take out a form of ‘insurance’ to protect against some or all of the losses incurred if the property needs to be taken into possession because of serious arrears. It is common practice for lenders to pass this charge on to the borrower. Depending on the amount of loan and the LTV the Higher Lending Guarantee charge can be a significant cost e.g. a Ł47,500 mortgage on a purchase price / valuation of Ł50,000 would result in a Ł750 charge on a typical MIG charge of 7.5% on a normal lending limit of 75% loan to value. Most lenders have a different name for this charge i.e. it may not appear on the mortgage Offer as Higher Lending Charge or High Percentage Lending Fee.

There are some important facts to understand about the Higher Lending charge. It acts as a form of insurance for the lender not the borrower. This means that the lender can claim part or all of its ‘losses’ incurred repossessing the property from the insurance company providing the MIG cover. Note that even after repossession the former borrower will remain liable for any sums owing (shortfall between selling price and mortgage outstanding plus arrears, lenders legal costs and any other charges applied to the mortgage) and can be pursued by the insurance company for payment at a subsequent date.
Valuation Fee

The amount charged to conduct a valuation of the property on behalf of the lender. It is important to note that the valuation is carried out on behalf of the lender - not the mortgage applicants! Frequently lenders include an administration fee as part of the valuation fee collected to cover the costs of arranging the valuation. The valuation does not represent a detailed inspection. For peace of mind it may be appropriate to obtain a ‘Housebuyers Report’ or a ‘Full Structural Survey’. These are more detailed than a lender valuation but they produced on behalf of the applicant. They are more expensive than the lenders valuation.
Booking Fee and Arrangement Fee

Both are up-front fees charges levied at the outset of the mortgage.

A booking fee will normally be required with the application form. A booking fee is paid to reserve funds on a mortgage product that has limited funds available e.g. a first-come, first-served fixed rate. Booking fees are often non-refundable, so if the mortgage applicant cancels the mortgage application before completion the fee will not be reimbursed.

An arrangement fee is typically charged on completion of the mortgage. Arrangement fees are common on fixed and capped rate mortgages. Frequently they can be added to the mortgage hence the fee does not become an ‘out of pocket’ expense.
Legal Fees

It is necessary to have a solicitor or licensed conveyancers to act on behalf of the mortgage applicant and the lender in the house purchase or remortgage transaction. The costs will be greater for house purchase than for remortgage. It is the role of the solicitor or licensed conveyancers to note ownership of the property on the title deeds; note the lenders interest in the property; register with the Land Registry and conduct searches to identify if there may be factors which could affect the property e.g. coal mining search to check for subsidence; check to see if there are some planned major road developments going through the back garden etc.
Insurance

Lenders will insist that the property is adequately insured, with a suitable Buildings Insurance Policy, as it represents security against the mortgage debt. A buildings policy covers against storm damage, fire, flooding etc and relates to the fabric of the house or flat etc. It is normal for lenders to check that any policy arranged is adequate and a fee will sometimes be levied to check the policy, if the borrowers take a policy other than the one sold or recommended by the lender. In addition, borrowers will need a Contents Policy that provides cover for the contents, such as carpets, TV’s, furniture etc. Most lenders and insurance companies offer a combined Buildings and Contents Policy. In the past some lenders have made their insurance compulsory with some very competitive mortgage products although this is less common now.

Another form of insurance common in the mortgage industry is a Mortgage Payment Protection Plan. This policy is designed to offer income protection against unemployment, sickness and redundancy. This form of insurance has become more important as the Department of Social Security has steadily withdrawn the benefits available. This form of insurance is not compulsory.

Another form of insurance is Higher Lending Guarantee. This is covered above.
Other Charges

There are a whole series of other fees that some lenders apply in certain circumstances e.g. arrears, late payment, removing the lenders name from the Title Deeds at the end of the mortgage. Under the terms of The Mortgage Code of Practice the lender will, before a mortgage applicant takes a mortgage, provide a tariff covering the repayment of the mortgage, including charges and additional interest costs payable in the vent of arrears and will advise of any other charges for services before or when the service is provided.

OTHER TERMINOLOGY

Adverse Credit

If a borrower has a history of poor credit usage then this is described as Adverse Credit. Poor Credit history can include County Court Judgements (CCJ), Bankruptcy, Mortgage arrears or any late payments on credit arrangements.
Arrears

This describes the amount the borrower is behind in his mortgage repayments schedule. The amount is usually measured in either pounds or months.
Bankrupt

A Corporation, Firm or individual who, via a court proceeding, is relieved from paying all debts once assets have been surrendered to an appointed third party designated by the court.
County Court Judgements (CCJ)

An adverse ruling by a County Court against a person who has not satisfied their debt payments with their creditors. Once the ruling has taken place it will be recorded against the persons credit history and will appear every time a credit search is done for the next seven years. If a person has a County Court Judgement against them it will have to be satisfied before they can get a mortgage. They will also find that the mortgages they can get will be at a higher interest rate.
Default

Failure of an individual to make payments on a mortgage at the correct time or to not comply with the mortgage companies requirements.