Money: A User’s Guide. Laura Whateley
the amount you pay month on month by opting for a longer term, but longer terms accrue more interest over time. It is a balancing act.
Similarly a mortgage with the cheapest interest rate is not always the cheapest deal over the longer term. You need to work out whether lower arrangement fees mean that you may be better off with a slightly higher interest rate, or vice versa. Banks are clever at making an offer look more attractive with low advertised rates but ultra-high arrangement fees.
Also look out for flexibility. Can you overpay your mortgage without being charged fees if you expect a bumper pay rise in the future? Can you take any break from mortgage payments without penalty if, for example, you know there’s a period when you will see a dip in earnings?
Should you get a fixed-rate or a tracker mortgage?
• BUT FIRST, WHAT IS THE BASE RATE?
The base rate is the national interest rate set by the Bank of England, and it is to the base rate that high-street banks and building societies peg their mortgage rates (as well as their savings rates, see chapter 5).
Following the Crash, the base rate was cut to a historic low of just 0.5 per cent, where it stayed until 2016, when it fell even further to 0.25 per cent. Low interest rates can help to revive the economy, they are good for businesses – borrowing is cheaper – and should make citizens spend rather than save. It is rising at the moment slightly, but is still at record lows. Young first-time buyers have never known anything other than cheap interest rates on mortgages, but it may not always be this way. In 1990, the base rate was nearly 15 per cent, in 1980 it was 17 per cent.
Variable rates, pros and cons
When choosing a mortgage one of the biggest decisions is whether to get a variable rate, a tracker-rate mortgage or a fixed-rate mortgage.
A variable rate is fairly self-explanatory. The mortgage lender sets the price of its variable rate and may at any point raise it or lower it; variable rates will rise when the base rate rises, but banks may set them as they like. All lenders will have a ‘standard variable rate’ (SVR), which is their default product that you will revert to whenever the special deal you might sign up for, say a two-year tracker, ends.
The SVR is usually more expensive than the best mortgage deals on the market, so it pays not to sit on it for any length of time, though many people do. Recent research by mortgage broker Dynamo suggested that a third of people whose mortgage deal expired in 2017 spent forty-two days on the SVR, which cost an average of £371 more than they needed to be paying, in ‘procrastination penalty’.
A tracker rate is a variable-rate mortgage, but one that is actually pegged to the base rate. So for example you might have a tracker-rate mortgage of 1.99 per cent, which would work out at an interest rate of 2.49 per cent when the base rate is at 0.5 per cent, and rise to 2.99 per cent if the base rate rose to 1 per cent.
The cost of your mortgage rises proportionally with the base rate. You can sign up to a tracker with various different lengths: a lifetime tracker runs for the full term of your mortgage, say twenty-five years, or you could have a two-, three-, five- or ten-year tracker.
Fixed rates pros and cons
Fixed rates do not alter with the base rate. You lock into a specific rate for a set period – two, three or five years normally, but increasingly ten-year fixed rates have come onto the market. Whether you go for a variable or a fixed rate comes down to how much you want to bet on base rates rising or falling. Fixed rates are best for people who want the certainty of knowing exactly how much they must pay month by month for their mortgage for the next few years, but they may be slightly more expensive. You need to make a clear-eyed decision, because you will pay high exit fees to get out of your deal, whether it is fixed or tracker: as much as 5 per cent of your mortgage in what is known as an early repayment charge (ERC).
You may also be charged an ERC for paying off a chunk of your mortgage at once, for example, if/when you win the lottery. Some deals let you overpay a certain percentage a year if you can afford to, but there is a limit.
When weighing up your options, consider that every time you move deal you will probably have to pay arrangement fees. If you are signing up for an inexpensive-seeming two-year deal, factor in that you will have to soon pay out arrangement fees when it comes to an end and you want a new rate.
On the other hand the downside of signing up for a deal that is very long, say a ten-year fix, is that you may struggle to transfer it to a new house if you intend to move. Some mortgage deals are ‘portable’, but if your circumstances have changed since you took it out, or your bank does not like the look of your new place, you may struggle.
Watch out for any small print that allows a bank to put up its tracker rates even when the base rate does not rise. Some have a ‘collar’ that stops your rate falling too low if the base rate falls below a certain minimum.
Buying with the Bank of Mum and Dad (BOMAD): top tips and family mortgages
The Bank of Mum and Dad became the UK’s ninth-biggest unofficial mortgage lender, in 2017 helping to fund 26 per cent of all UK property transactions, on a par with Yorkshire Building Society, according to research by Legal & General. Of those under thirty-five seeking to buy in 2017, 62 per cent were being partially bankrolled by parents or other family members.
This has bred a new category of family mortgages. David Hollingworth, of broker London & Country, says you should not necessarily head straight for something badged up a first-time buyer deal – a normal mortgage might be cheaper or more appropriate. Nevertheless if you are struggling with a deposit there are some innovative solutions.
Barclays Family Springboard will lend as much as 100 per cent LTV as long as your parent will lock 10 per cent of the property price (i.e. the 10 per cent deposit they might otherwise have given you) in cash into a linked savings account as additional security. This means your parent keeps their cash in their name rather than giving it to you, and will be able to access it at a later date, within three years, assuming you make all your mortgage payments on time.
Post Office’s Family Link gives you the opportunity to take out two mortgages on two properties, 90 per cent LTV on the one you want to buy and 10 per cent against your parents’ home. You the buyer pay off both loans, but the 10 per cent one is interest-free, though you have to clear it within five years. You must be a first-time buyer to take advantage of this, and your parents must have an income of at least £20,000.
Aldermore has a similar concept, a Family Guarantee mortgage, again at 100 per cent LTV, which allows parents to use spare equity in their own home as security, rather than cash, as do Family Building Society and Bath Building Society. The major drawback of these is that your parents’ home is at risk of being repossessed if you cannot pay your mortgage, which could make for some tense Sunday lunches. They are also more expensive than conventional mortgages. If your parents can afford to give you cash instead, you will get a better interest rate.
If your parents or grandparents are giving you some or all of your deposit in cash, lenders will want to know whether it is a gift or a loan, and whether the money has any strings attached, such as having to repay them monthly. This will affect the perceived affordability of your mortgage and therefore how much you can borrow. A ‘soft loan’, which is where your parents expect to be repaid, but only when you sell your property, therefore no monthly repayments are required, is not a problem. Banks will often require a letter from your parents confirming that the money is a gift, or a ‘soft loan’.
First-time buyer schemes to help you buy (with or without BOMAD)