Steps to Choosing a Mortgage
A mortgage is one of the biggest financial decisions in most people's lives. And so it is important that as a homebuyer, you get a mortgage that is suited to your financial situation. However, when you start looking for a mortgage, you will come across hundreds of different products with different features. For the average homebuyer, it is hard to distinguish the difference between different mortgages. In this article, we look at some steps you need to take before choosing a new mortgage.
Decide on the type of the mortgage
As a first step, you need to decide what type of mortgage is suited to you. While there are many types of mortgages, you will have to choose broadly on the basis of two different criteria: a) type of interest charged by the mortgage, and b) the structure of the monthly repayment amount.
Type of interest charged by a mortgage - fixed rate or variable rate:
You should decide whether you want to go for a fixed rate or a variable rate mortgage. With a fixed rate mortgage, your interest rate will be fixed for a certain period of say 2 to 5 years, resulting in fixed monthly repayments. With a variable rate mortgage, your interest rates will vary based on different factors, and your monthly repayments will either increase or decrease depending on the movements in interest rate. A few years ago, variable rates used to be a cheaper option between the two types, but nowadays, you can get some very good deals even on fixed rate mortgages.
Structure of the monthly repayment amount - repayment or interest only mortgage:
With a repayment mortgage, your monthly repayments will include both the principal and interest. And with an interest only mortgage, your monthly repayments comprise of only interest.
Typically, the monthly repayments are lower in the case of interest-only mortgages, but it is important to have a separate plan for repayment of the debt.
Of the two, repayment mortgages are a more popular option as there is no need to create a separate repayment plan. Interest-only options were commonly available before April 2014. However, after the new mortgage lending rules came into effect, the government has made it compulsory for lenders to ask for a solid repayment plan before providing interest-only mortgages.
Assess your cash situation realistically
While getting a mortgage, you need to be prepared for spending a whole lot of cash. For instance, you need to pay a deposit of at least 5% of your property's price to the mortgage lending company. Deposit is directly related to the total interest payment and the total repayment amount. If you pay a higher deposit, you will borrow less, and so you will pay less in interest.
Similarly, there will be other expenses like stamp duty, mortgage fees, legal fees, valuation fees, survey costs, etc., and you need to have enough cash for these expenses. You should also realize that as soon as your monthly repayments kick in, you will be left with less cash every month for your household expenses.
Knowing your cash situation will help you while seeking mortgages because some mortgage products require a high minimum deposit amount. For example, Post Office 2 Year 1.43% Fixed mortgage has a loan-to-value (LTV) ratio of 60%. In other words, you can get this mortgage only for 60% of the property value, and you need to pay the remaining 40% as deposit.
If you know that you have only 5% or 10% amount as deposit, you can straightaway rule out the mortgages with high LTV requirements.
Perform research on different mortgage options
Once you have decided on the mortgage type, you can start looking for different deals. The choice of the deal will depend on the value of your property and the available deposit amount.
As a first step, you should talk to your bank and building society to get an idea of the different mortgages on offer. Note, however you should not straightaway zero in on your existing bank. You should check the different mortgage products available on various comparison sites. For example, you can check the mortgage comparison table on the website of Money Advice Service, an independent financial advisory service set up by the UK government.
Check deals with mortgage brokers
Once you have made a list of the offers from your bank, and some offers from comparison websites, you should also check for deals with a few mortgage brokers. An advantage of mortgage brokers is they have access to many lenders. Brokers can also advise you on the most suitable type of mortgages based on your need. Also, since mortgage brokers are involved in mortgages on a full-time basis, they understand the lending criteria of different mortgage lenders. This way, you can apply to a lender who is best suited to your specific situation, and avoid any unnecessary rejections.
Note that it is important to find a good mortgage broker. Your estate agent may recommend you some brokers, but there is no compulsion to use these brokers even if you buy a property through the same estate agent. It is a good idea to look for some independent mortgage advisors as they can provide you with unbiased advice on different mortgage products. You can also check with your existing connections for any references of mortgage brokers.
Check if a mortgage broker has access to all deals
Before shortlisting a broker, you need to check if the broker has access to all lenders in the UK. You may get one of the three responses listed below:
- The brokers may say no because they may be tied to a specific lender or a small group of lenders. This means they will have access to only a few deals and may lose out on other attractive deals.
- The brokers may say they have access to all deals available to brokers. This means they will exclude any deals directly available to the general public as they may not be able to earn a commission on such deals.
- The brokers may say they have access to all lenders. While it's practically impossible to check all deals and mortgages on offer in the UK, such brokers can provide you with a wider range of options as opposed to the earlier two.
Based on the responses you can decide whether you want to deal with the broker or not.
Ask the mortgage broker about fees
Upon shortlisting, you need to check if there is a fee for using the broker's services. Brokers make money either through a commission from the lender or by charging a fee to the borrower.
Commission: Most lenders pay a 'procuration fee' to the broker, which is typically 0.35% of the loan amount. The higher the loan amount, the greater the commission to the broker. You should note this is a transaction between the lender and broker, and it doesn't affect your borrowing costs.
Brokers are legally obligated to inform borrowers about how much commission they are going to charge the lender. You can find this information in the Key Facts illustration.
Fees: Some brokers may charge a fee to the borrowers. This could be in addition to the commission earned from lenders. Independent brokers offer the borrowers a choice between a fee and a commission.
Most mortgage brokers will charge a fee of around 1% of the loan amount. Stay away from brokers who are charging more than 1%. Also, avoid brokers who are asking for a fee prior to the transaction because you may end up paying even if your deal doesn't materialise.
You should also check if the broker has the necessary qualifications for advising. CeMAP (Certificate in Mortgage Advice and Practice) is the most accepted qualification for brokers. A qualified broker will understand the requirements and eligibility of the borrower in detail and advice only on the most suitable products. Going to a qualified broker can reduce the borrower's risk. If a qualified broker provides you with incorrect advice, you can complain to the Financial Ombudsman, and they will perform an investigation on the broker.
Some examples of independent mortgage advisors are Mortgage Advise Bureau or John Charcoal. London & Country mortgages doesn't charge a fee to the borrowers and has access to all deals, which are available only to brokers and not to the general public. You can also check websites like Unbiased.co.uk for a list of mortgage brokers.
Check for deals that may have been missed by brokers
If you've done detailed research on all comparison websites prior to visiting a broker, or if you have chosen a broker who has access to all deals and lenders, there are very less chances of you missing out on any attractive deals.
However, as a second check you should look out for some of the following types of lenders.
- Lenders who deal directly with borrowers and not through brokers: Some examples of such lenders are Tesco Bank and First Direct. Brokers will not provide you any deals offered by such lenders.
- Lenders who don't pay a fee to the brokers: There's no incentive for brokers to offer you any deals available from these lenders. One example of such a lender is Yorkshire Building Society.
- Lenders who offer only select deals through brokers: This will require some effort, but you need to find the deals that lenders offer through brokers and the deals which are offered directly. You should find out if there are any better deals, which may not be available for brokers, but are available only to the general public.
Ignore the APR
APR is the effective annual percentage rate of a mortgage if it's held for the full term, which is typically 25 years. However, most borrowers don't stick to one mortgage for 25 years. They either repay the mortgage before 25 years or go for a remortgage.
Example 1: Let's take the example of a mortgage deal -- Post Office 2 Year 1.43% Fixed. The interest rate on this mortgage is fixed at 1.43% until 31 Dec 2016 and subsequently the interest increases to a variable rate of 4.49% for the remaining term of the loan. This works out to an APR of 4.1% for the entire term of the loan.
Let's look at another deal. Chelsea Building Society 2 year 1.38% fixed has a fixed mortgage of 1.38% till January 2017, and a rate of 5.45% for the rest of the term. Because of the higher rate for the rest of the term, the APR for this deal works out to 4.9%.
If you take a decision on the basis of APR, you are likely to go for the Post Office deal. However, in reality, the deal from Chelsea Building Society is more attractive. That's because the fixed rate for the discount period is lesser in the Chelsea Building Society deal, and also the discount period is longer by 1 month. At the end of the fixed period, you are likely to go for a remortgage, so the APR is meaningless.
For this reason, it is not appropriate to shortlist a mortgage based on APR. While shortlisting a mortgage, you need to look out for the interest rate charged for the initial period, the fees charged by the lender, and the interest rate after the offer period ends.
Check all mortgage-related documents
You will come across a lot of documents in the process of getting a mortgage. Some of these documents are listed below.
Key facts illustration
As the name suggests, the key facts illustration provides all key facts related to a mortgage. You should get a copy of the key facts prior to applying for a new mortgage. In order to determine the authenticity of the key facts illustration, you should check for the following.
- The document should have a Key Facts logo
- It should have the correct date
- It should have your name
- It should have the name of the creator of key facts. This is either the lender if you have applied directly or the broker if you've applied via the broker.
You should check the document if all the information is available; if not ask for a new key facts illustration. The document plays an important role if there's a disagreement with the lender in the future; therefore, you should store it safely.
The mortgage offer
If your mortgage application is successful, your lender will send you a mortgage offer. The offer will include all the facts related to the mortgage and the terms and conditions of lending.
While it's a long document and reading it fully may require a lot of effort, it is important that you validate all the details in the offer. You should check if all the facts are in line with the key facts illustration. You should also check all the key numbers such as lenders fees, any charges for early repayment of the loan, etc. Once you sign the offer, it means you've accepted the conditions.
Avoid other products offered unless necessary
Once you've chosen a mortgage, mortgage lenders and brokers may try to cross-sell other products to extract more money from you. Some of these products include:
- Mortgage payment protection insurance (MPPI)
- Buildings/contents insurance
- Life cover
You should decline the offer straightaway if you don't need these products. Even if you need any of these, you should check the market before buying them from the lender/broker. There are very high chances of you finding better deals for such products in the market.
Shortlisting a mortgage is a long process and requires a lot of efforts and patience. But, if you don't look for the right deal, you will end up paying a higher interest and a higher total repayment amount. Therefore, you need to follow all the steps mentioned above to make sure you get the correct deal.
Use our mortgage calculator to calculate the monthly repayment and total amount repayable based on different interest rates and different loan terms.
Use our mortgage calculator to calculate the repayment amounts for different mortgage amounts at different interest rates.
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