Choosing a mortgage
Pitfalls and Penalties
It's not that lenders are out to get you, but there are
quite a few features of many mortgages that can come as
a nasty surprise if they catch you unawares.
Early redemption penalties
This is the most common of all the pitfalls that are found
with mortgages. Any special offers usually only last for
a set period of time. During this period you will be severely
penalised if you try to switch to another product or mortgage
provider, either by selling your house or by remortgaging.
The mortgage market is so competitive that many products
are sold as a 'loss leader' - meaning that the lender will
not make a profit on the deal until you have held the product
for a number of years. Lenders compensate for this by making
sure you hold on to the product until they make a profit,
by charging extremely punitive fees if you try and switch
before then.
Redemption penalties can be stepped just like discounts,
and can be particularly severe within the first year. This
is to try and ensure that the costs that the lender endures
in setting up the mortgage are always covered, regardless
of whether or not you stick with the mortgage. Penalties
are also particularly severe in the non-conforming market
where can be as high as 5 or even 6 percent of the loan
value for the fist 3 years.
Redemption penalties can be a fixed sum of money, though
it is more usual to see a proportion of the loan, or an
amount of interest used as a deterrent to cashing in early.
A 'fine' of up to six months' worth of additional interest
is common, though it may easily be as high as one year's
worth of interest. With cashback mortgages, you often have
to repay the amount of money you received as cashback. The
total redemption penalty can run into thousands of pounds,
which is usually enough to put most people off the idea
of switching.
The duration of the penalty period varies from mortgage
to mortgage, though a great many products have no early
redemption charges whatsoever. There is frequently a trade-off
between getting a competitive interest rate for a lengthy
fixed or discounted period and making yourself vulnerable
to early redemption charges. Sometimes, however, there is
an overhang, where the redemption period extends beyond
the introductory offer. Where there are 'extended' redemption
penalties, you can be tied in to paying the uncompetitive
Standard Variable Rate (SVR) for a period of time after
the introductory offer period, as the lender seeks to recoup
some of the cost of offering you such a competitive rate.
Redemption penalties are normally waived in the event of
death.
Flexibility of payment size
You should find out whether you are able to increase or
decrease your payments should your circumstances change.
Some mortgage lenders are very strict about allowing you
to alter the terms of your mortgage and it is better to
know this up front.
Also find out whether you can make lump sum repayments.
If you can, there may well be maximum and minimum amounts
that you are allowed to pay off. If you come into some money,
it can be a good idea to pay off a chunk of your mortgage,
as this will reduce the total amount of interest you pay
over the life of the loan. You should also find out when
the account is credited, as it may be on a fixed date each
year. If this is the case, you may as well delay paying
the money in until just before that date. There is no point
paying it in if it has no immediate effect on your outstanding
capital, when it could be earning you interest elsewhere.
You will not normally be able to make lump sum repayments
during the redemption penalty period.
Required products
Many lenders will insist on you taking up certain 'mandatory'
products when you buy a mortgage. These can include household
insurance, life assurance or accident, sickness and unemployment
cover. Mandatory products that you are forced to purchase
directly from the provider are not always very competitive.
As with all products, the actual cost of mandatory insurance
will vary, but most policies from lenders will cost you
more than they would on the open market, often by as much
as 30 or 40 percent. For some policies, this can equate
to as much as an extra quarter of a percent on your interest
rate.
Default
If you default on your payments, the lender will eventually
be entitled to sell your home in order to recover the loan.
Whilst this is an eventuality that most people will not
want to consider, it may be worth seeing if you can find
out what the lender's stance is on this. Different lenders
will have different policies on how long they give you before
they start the proceedings to recover the loan. Many will
have a separate schedule of charges which you will incur
before they start proceedings.
Most lenders will only repossess your home as a last resort.
Most mainstream lenders subscribe to The Mortgage Code,
which binds them to consider all cases of mortgage arrears
sympathetically and positively.
If they do remove you and sell the house, the lender is
only entitled to keep the amount of money owed to them -
any outstanding capital and interest as well as the expenses
they incur in repossessing your home. The remainder of the
sale price is passed back to you. If you have gone into
negative equity, unfortunately you will still owe the lender
the balance of the debt, less the property sale price. They
may then try to liquidise any other assets you have, in
order to cover the remaining debt and you could even end
up being declared bankrupt.
Guarantors
If a lender is concerned about your ability to repay your
loan, they may require you to find a guarantor for the loan.
The guarantor is then responsible for payments if you default.
