Mortgages

What is a Mortgage?

What is a Mortgage? A mortgage is a form of security for a loan used to buy a property. A legal contract (the mortgage) ‘pledges’ the property to the lender until the loan is fully repaid. Typically, a mortgage will run for a term of 25 years and be repaid in monthly instalments using a rate of interest determined by the lender. This rate will be influenced by a number of factors (Bank of England base rates for example). Today, traditional mortgage lenders (banks and building societies) have been joined by specialist lenders and on–line companies to offer a wide range of products. A 'mortgage' is a loan secured against your home. 'Secured' means that if you do not keep up the payments, the lender can sell your home to get its money back. Your home may be repossessed if you do not keep up repayments on your mortgage.

The banking and mortgage code (www.gba.gi) is a voluntary code, which sets standards of good banking practice for banks and building societies in Gibraltar to follow when they are dealing with personal customers. As a voluntary code, it allows competition and market forces to work to encourage higher standards for the benefit of customers. Terms within Bank/Customer agreements will always take preference over terms within this code.

What does LTV stand for?

When applying for a mortgage, your adviser might inform you that the bank cannot lend 100% of the price of the home you are looking to buy. The Loan to Value (LTV) ratio is the relationship, expressed as a percentage, between the amount of a loan and the value (confirmed by the valuer) of the property which will eventually secure the finance. The bank does this for several reasons. For example, to safeguard the lending in the event that the property depreciates in value or in the event that the mortgagee needs to sell the property at a reduced price as a result of a quick sale.

In a residential mortgage loan for example, a £160,000 mortgage on a property valued at £200,000 has an LTV ratio of 80%. Typically a bank will lend no more than 90%, or in some cases 95% LTV. Usually the LTV is dependant on a number of things, for example: market rivalry, personal circumstances of the mortgagee or if the customers are first-time buyers.

LTV also applies to shared ownership schemes, where both the mortgagee and the government own a certain percentage of the property. When this is the case, the bank or building society may, again, be willing to lend up to 100% but in this case it will be up to 100% of the percentage the mortgagee will be purchasing. For example, if a person is purchasing a property worth £150,000 on a 60% basis, this person would be able to borrow up to £90,000.

How much should or can I borrow?

Different banks will have different criterion for the amount that individuals can borrow, however, typically you can borrow up to three and-a-half times the main earner’s income (before tax), plus one times any second earner’s income, or alternatively two-and-a-half times their joint incomes (if this is larger). Most banks usually refer to this as ‘the multiplier rule’. There are usually exceptions for young professionals who can sometimes obtain a mortgage for up to four times joint incomes because it is expected that they will have much higher salaries in the future and will be able to afford the mortgage in the long run.

The multiplier rule is not stand-alone and therefore your bank would want to look at the overall picture of your finances. If you have a considerable amount of outgoings in the form of loans or bills, the bank may determine that it would be hard, or impossible for you to make the monthly payments and will therefore consider the mortgage as being a high risk. Your bank may also only be willing to count half of income deriving from overtime, commission or bonuses unless this is guaranteed.

If you are getting advice, the adviser has a duty to take reasonable steps to ensure that you can afford the mortgage that they are recommending. Whether or not you get advice, lenders are required to lend responsibly. This means that they should, based on factors such as your income, expenditure and other circumstances, consider whether you can keep up the mortgage repayments now and in the future.

Types of interest rates

Choosing between interest rates and mortgages on offer can become very confusing. You have two basic decisions when choosing an interest rate deal;

The following table illustrates some examples of different types of interest rate deals for mortgagees:

Interest Rate Features Is there an early repayment charge? Advantages Disadvantages
Standard Variable Rate Payments fluctuate (go up or down) in line with the bank's rate changes Not usually - however there can be if you were offered a cash-back deal Often, this choice offers the customer the ability to make 'overpayments' and therefore pay back the mortgage earlier than anticipated. Payments may increase and therefore may be not able to keep up with repayments
Base-rate Tracker This is a variable rate, where the rate is set at a certain percentage above or below the base rate and tracks these changes Usually there is a 'special deal period' where there will be a charge, however this changes from bank to bank You can take advantage when the base rate is at a low and can usually overpay as and when able to   Payments may increase and therefore may not be able to keep up with repayments
Fixed Interest Rates Your payments are set at a certain level for a set period of time - for example, two years, five years, ten years or even longer.  Unless the rate is fixed for the term of the mortgage, you are usually charged the lender's standard variable rate at the end of the fixed rate period Yes - usually even after the set period, however some banks will provide the opportunity to change to a different deal at that time for the remaining amount of the mortgage You are able to determine your outgoings with certainty for the set periods.  Also if it is predicted or you think that rates will rise, then you can take advantage of a dip in interest rates If the interest rate falls, you may be paying more than the current interest rate, and you are not able to make overpayments when you have a surplus of cash
Discounted Rates Payments are variable, however are set at less than the bank's standard variable rate for a set period of time.  At the end of this period, you are usually charged the bank's standard variable rate Yes - during the discounted period and possibly for some time after Young professionals will take most advantage of this, where they earn less at the beginning of employment however expect to earn higher as they progress When the discount period ends, payments will go up and might not be able to deal with the increased expense, or if interest rates rise significantly
Capped Rates Payments are variable and often linked to a base rate, but are fixed not to go above a set level (the 'ceiling' or 'cap') during the period of the deal.  At the end of the period, you are usually charged the lender's standard variable rate Yes - during the capped period and possibly for some time after You know the maximum you will be liable to pay over a set period and is beneficial if you think interest rates are likely to increase.  You also have the security of knowing that your payments can't rise above the set level, but still have the chance of benefiting from any falls in interest rates Can be a disadvantage if you can find a fixed rate set at a lower rate than the cap and you think rates are unlikely to fall below the level of the fixed rate deal
Standard Variable Rate with cash-back Same as a standard variable rate but you receive a sum (for example, 3-5% of the amount borrowed) shortly after you take up the loan to help out with the initial costs of buying a home Yes - and will normally have to repay some or all of the cash-back if you repay the mortgage in the early years Receive a cash sum when you most need it - i.e. to buy furniture etc and if you expect that the cash sum compensates for any interest rate If you can manage without the cash back now, this would be a disadvantage because you could get a better overall deal, and you might not be able to cope with increased payments

What looks like a more expensive mortgage today may end up being more suitable for you in the long run – look at the long-term picture. Make sure you know what happens after any special deal ends. Ask your bank if you would be entitled to switch to a different mortgage type after any special offer periods.

Repaying a mortgage

There are two main methods for repaying a mortgage: ‘Capital and Interest’ and ‘Interest Only’. Capital and Interest is when you pay back part of the loan and the interest on it with each monthly payment. Providing you make all of the repayments due, the loan will be fully repaid at the end of the mortgage term.


With an Interest Only mortgage the repayment you make is simply the interest you owe on the loan each month. At the end of the mortgage term (usually 25 years), the full amount of the loan is still outstanding and you must then repay this amount, either from savings, from an investment vehicle (such as an endowment policy) or from the proceeds of the sale of the house. It is your responsibility to make sure you have enough money to repay the mortgage at the end of the term; otherwise you could lose your home. Some banks and building societies may offer the possibility of choosing both where, for example, 30% of the mortgage could be interest only and the remaining percentage could be capital and interest or vice versa. Different percentage splits may be possible but this would be dependant on individual banks’ terms and conditions.


With an interest-only mortgage, your monthly payments only pay the mortgage interest. The size of the loan usually stays the same and you gain no capital until the loan is repaid. With a capital repayment mortgage your monthly payments gradually pay off the loan as well as the interest and you go gaining capital in the property. The graphs below show an illustration of the two types of mortgages:

Features of the two types of repayment methods:

  Interest-Only Mortgage Capital Repayment Mortgage
What if interest rates rise? Payments will increase regardless of repayment type Payments will increase regardless of repayment type
Will it pay off the mortgage? Not on its own.  You need to have some other arrangement for repaying the loan.  You will need to make monthly payments to a savings or investment plan to build up a lump sum, however there is a risk that the plan will not grow enough to pay off the mortgage in full As long as you pay all the monthly instalments agreed with the bank, the whole loan will be repaid by the end of the mortgage term
Moving home / re-mortgaging - you will need to repay the mortgage and start a new one Because you won't have repaid any 'capital' you will need to pay off the same amount that you borrowed.  But you can carry over any accompanying savings plan to your new mortgage and the mortgage term for this part of the loan will be what's left of the term of the plan (that is, you don't need to start again).  If the new mortgage is bigger than the old one, you need to decide how you will pay off the extra loan (this could be done on a repayment or interest-only basis) You will usually have paid off some of the 'capital' and so will need to pay back less than you borrowed.  When arranging you new mortgage, even if you are borrowing more, see if you can afford the new monthly payments over the term that you had left on the last mortgage - you don't have to take a repayment mortgage over 25 years.
What if you have problems keeping to monthly payments? Your lender might agree to reduce or even stop the mortgage payments for a while (known as a payment holiday).  But you will not necessarily be able to reduce the amount you pay each month into a savings scheme (particularly if it is an endowment policy) You could ask you bank to extend the term or accept interest-only payments for a while.  This reduces the amount you pay each month in the short term but increases the total cost of the loan.  Your bank might agree to stop your payments for a while
Is this a suitable mortgage for you? If you are comfortable accepting the risk of repaying a mortgage with a savings plan which is linked to the stock market, then this form of repayment could be suitable for you.  However, you might want to bear in mind that the plan might have a shortfall at the end of the term and have to take out a further loan at the end of the term This repayment plan is more suited to individuals who want the security of knowing that there will not be a shortfall at the end of the repayment term, although monthly payments could increase if interest rates rise

Different ways of paying off an interest-only mortgage:

If you choose an interest-only mortgage, make sure you know from the outset how you eventually intend to pay off the loan – your bank will also want confirmation of this. You do not have to arrange this through your bank. Your main options are to:

Convert to a repayment mortgage later:

This might be a suitable option if, say, your earnings are low now but are expected to be much higher in future, for example, when you've finished training or gained professional qualifications. Using an interest-only mortgage keeps your monthly payments down until you can afford the higher monthly payments of a repayment mortgage.

Because you're putting off repaying the capital you will end up paying more interest and more in total for your mortgage over the term.
Use a lump sum from somewhere else

For example, an inheritance or the proceeds of the sale of an asset, such as another property or a business. This is usually a risky strategy - how sure are you that the inheritance will materialise or what happens if your business fails?

Sell the mortgaged property to pay off the loan:

This is suitable only if you do not need to live in the property - for example, if it is a buy-to-let property or a second home, or you are buying something smaller or cheaper.

Endowment mortgage policies

Please use the following link for more information on endowment mortgages http://www.fsc.gi/consumer/investmentmortgages.htm

What are the fees and costs

Buying a house is an expensive affair and time and care must be taken when embarking on decisions as regards to this. However the costs involved in obtaining a mortgage need not be expensive.

Adding fees to the mortgage

Often you can add certain fees charged by the bank to the mortgage. This can help with the initial cost of the mortgage but will cost you more in the long run as you will pay interest on the fees.

Incentives

Lenders sometimes offer incentives which reduce the cost to you of taking out the mortgage. This can range from a free valuation or legal fees paid to a small or large cash-back. If you want to pay off your mortgage early, you may have to pay back the value of these.

What will you have to pay?

Fee or charge What for? How much?
Mortgage booking fee or mortgage arrangement fee A commitment or administration fee usually payable to the lender to reserve the mortgage funds. Varies but typically £100-£500.
Valuation fee To assess that the property is appropriate security for the mortgage. Depends on lender and value of property.
Higher lending charge To get insurance cover in case you don't pay the mortgage, and they repossess your home and have to sell it at a loss. Depends on how much you borrow and the size of your deposit.
Fee to insure your property If you do not insure your property through the lender. Typically £25 but may be payable yearly or each time you change insurer.
Telegraphic transfer For your solicitor if you've arranged to transfer the mortgage funds electronically the same day. Typically £40-£50.
Re-inspection fee If the lender needs to re-inspect the property after the original valuation, usually to check if you've made agreed repairs. Typically £50-100.
Early repayment charge If you repay your mortgage early. Depends on the terms and conditions of your mortgage and the size of your loan.
Fees to repay the mortgage For your lender when you repay your mortgage. Typically £75-200 as-well as any early repayment charge.

Mortgages - other fees you may have to pay

The table below sets out the other fees and charges you might have to pay.

Fee or charge What for?       How much?
Estate agency fee Marketing and selling your home. Typically 1-3% of the selling price. Ask for a quote.
Stamp duty Tax payable to the government when buying, although properties below £160k are now not liable to pay stamp duty  Varies depending on purchase price.  Properties priced between £160K and £250K will have 1.26% stamp duty payable. Properties priced between £250k and £350k will have  1.6% of stamp duty  payable and properties priced £350K and above will have stamp duty payable of 2.5 %.
Legal fees For solicitor, searches, land registry etc (normally called conveyance) Usually the fee is 1% of the property value, although this is discretionary.  Ask for a quote
Survey fee To surveyor if you want a more detailed report on the property. Varies according to surveyor and type of report.  Ask for a quote.

Other issues

Review your mortgage

Every year your bank is required to send you a statement which offers a good opportunity to check your mortgage and consider any changes.
You should also review your mortgage whenever the period of a special deal, for example, a fixed or discounted interest rate, comes to an end.

Your annual statement

Use your annual statement to check that your mortgage details are as you would expect them to be. The statement will include:

The date and amount of payments you have made during the year compared to those that were due, including payments for any tied products that you took out through the lender (for example, buildings insurance);
 

If you have a repayment mortgage, the balance shown on your statement should get smaller over the years (as illustrated in the diagram earlier).

If you have an interest-only mortgage, the balance should stay the same, unless you choose to make some early capital repayment.

If you have an interest-only mortgage (or part of your loan is on that basis), the statement should either give details of any savings scheme you have taken out through the lender or warn you that you should have some arrangement in place for repaying the mortgage at the end of its term. Check that it is on track to do this.

Are you getting a good deal?

If you move home, you'll probably shop around to find a competitive mortgage. Even if you are not moving, there is no reason to stick with a poor deal.

Questions to ask yourself

Q Are you still on a special deal or are you now paying the lender's standard variable rate?

If you are still on a good deal then make a note of when this finishes and remember to review it again closer to this time.

Q Would you have to pay an early repayment charge to switch?

It may not be worthwhile switching yet depending on how much the charge is. If this is the case, make a note of the date that the early repayment charge will no longer be payable (from your annual statement) and review it again closer to the time.

Q Are you paying the lender's standard variable rate and there are no early repayment charges?

You should definitely review the products in the market and see if you can save money by switching to a new deal. Use the information in your annual statement, to compare your mortgage with other mortgages available both from your current lender, and from other lenders. Use the information in your statement such as the amount you owe, the term remaining, the interest rate and monthly payment to shop around.

Switching your mortgage

In the past people would normally stick to the same mortgage deal for the duration of the loan, however, nowadays it is common to shop around every few years to make sure you are getting a good deal.

Switching could potentially cut your monthly payments by up to half - although you would need to weigh up these monthly savings or other benefits against the up-front costs of making the switch.

Which type of deal do you want?

You do not have to stick with the same repayment method. If you are switching from an interest-only to a repayment mortgage, you do not have to stop or cash in any associated savings or investments scheme.

Switching can be an opportunity to borrow extra money, especially if the value of your home has increased since you took out your existing mortgage. But do not borrow more than you can afford to pay back. Do not forget that you may be saving money now which means you can afford the new payment, but this payment could still go up in future unless you take a long-term fixed rate.

When switching your mortgage, this can also be a good opportunity to pay off some of your mortgage and borrow less.

What will it cost you?

Your mortgage might have early repayment charges, especially in the early years, these can be hefty if you are still in the period of a special deal, such as a fixed, discounted or cash-back mortgage.

Even if there are no early repayment charges, your lender might make an administration charge and if you are switching to a new lender, your home will have to be valued and there will be legal costs to pay. With some mortgage deals, the lender will pay these fees for you.

If you are switching lender, check whether your current lender will charge you interest to the end of the month even if you pay off the mortgage earlier. In this case, make sure you switch your mortgage at the end of the month.

Make sure you recoup the costs of switching over a period which is less than any special deal – for example, over less than two years if you switch to a two-year discounted rate.

Remember that if a deal has no fees the rate might not be as good as one that charges fees.

The standard mortgage process

The following diagram depicts the standard mortgage process that one might expect to go through when buying your home:

1) You identify your dream home and arrange for a viewing.

2) Visit your bank to get an agreement in principle and to see if you can afford the monthly payments.

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