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› Mortgage and Insurance Reference Guide
This reference guide is designed to help you to understand matters relating to your mortgage and insurances that we will be discussing with you.
These topics will be discussed with you as part of the service provided. It is important that you have this document to provide you with a reference to the various topics you need to consider. If you have any questions please do not hesitate to ask.
› Types of Mortgage
To help you to decide the most appropriate mortgage to meet your requirements, the following is an explanation of what is available, a description of them, as well as the advantages and disadvantages.
- Fixed Rate
- Variable Rate (including Flexible and Current Account, LIBOR and Tracker)
- Capped Rate (and Collared)
- Discount Rate
A fixed rate mortgage is one where for a period of time the interest rate is set and will not be affected by changes in interest rates. At the end of the period the interest rate will become the variable rate applicable at that time. Usually the rate is fixed between 2 and 5 years, although sometimes longer periods are available.
Advantages:
- Provides guaranteed mortgage repayments for the duration of the fixed period giving protection from rising interest rates
- Variety of periods beginning as short as six months, so likely to be one to meet most needs
Disadvantages:
- Probably have to pay an upfront application fee and/or an arrangement fee once the loan is taken
- If interest rates fall below your fixed rate you may be left paying a higher rate than the variable rate
- If you redeem your mortgage during the fixed period and often for a period afterwards, you may have to pay a penalty. This is usually several months' interest repayments.
A variable rate mortgage is one that changes when the lender announces interest rate changes. So unlike a fixed rate, if the mortgage rate goes up then you will be paying more each month. Equally if it goes down then you pay less.
Advantages:
- Your monthly repayments will fall with reductions in interest rates
- Gives you flexibility
Disadvantages:
- Your repayments will rise with interest rates
- Does not give you the ability to budget for repayments
These types of mortgages have been introduced more recently. They have been introduced to cater to the changing patterns in working and life styles.
There are several attractive features. One of the main ones is that interest is usually calculated daily rather than being applied monthly or yearly. This means that interest does not accumulate and therefore, monthly payments are kept to a minimum.
This type of mortgage also allows overpayments. So if you decide that you wish to pay off a lump sum you can do so and by doing so reduce the interest. This can make quite a big difference to how much you pay in interest over the course of the mortgage and allows you to pay the mortgage off early if you wish.
You can also draw down overpayments should you need the money you overpaid at a later date.
Current account mortgages group together all your borrowings and savings. This means that all your borrowings are at the mortgage rate, which is usually considerably less than personal loan and credit card rates.
Usually you have your savings held in this type of mortgage and your salary paid into it. This means that as interest is calculated daily you only ever pay interest on the actual amount you owe.
Advantages:
- Daily interest
- Overpayment facility - potential to reduce amount paid in interest and reduce the term
- Underpayment facility - particularly useful in times of hardship
- Current account mortgages give good rates of interest on borrowings and savings
- Current account mortgages ensure your interest payments are kept to a minimum
Disadvantages:
- These mortgages need to be managed carefully to take advantage of the benefits and, more importantly, to make sure they are repaid at the end of the period of the loan. This makes them less attractive to people who do not want to have to manage their mortgage.
- This type of mortgage could encourage people to over stretch themselves on their borrowings
LIBOR (London Interbank Ordinary Rate) and Tracker Mortgages
These mortgages are a variation of a variable rate mortgage. They guarantee to be a certain percentage in excess of the London Interbank Ordinary Rate (which is the interest rate that the Bank of England lends to commercial banks) or the Bank of England base rate in the case of most tracker mortgages. So as the LIBOR or Bank of England base rate changes the LIBOR or tracker mortgage rate does by the same amount. If the Bank of England base rate were 5%, and the tracker mortgage was guaranteed to be 2% greater, you would then be paying 7%. If the base rate were to go up 1% to 6% you would then be paying 8%.
Advantages:
- The interest rate you pay moves immediately as the base rate changes. Lenders rarely pass on changes to borrowers immediately
- You are guaranteed the percentage rate that your loan will exceed the base rate by. This prevents you from suffering from your lender becoming uncompetitive with their existing borrowers' standard variable rate
Disadvantages:
- You need to make sure you get a competitive guaranteed rate above the base rate and that the base that the lender uses is also competitive, as this can sometimes be a rate set by the lender rather than using an independent rate such as LIBOR or Bank of England base rate
- When rates rise you are subject to the increase immediately
A capped rate mortgage puts a ceiling on the rate for a period of time. This means that the payments cannot go above the rate set during that time. It can of course change if the rates go down.
Advantages:
- Gives you a guaranteed rate which your repayments cannot exceed
- If interest rates fall your repayments will reduce with them
Disadvantages:
- Usually the capped rate is higher than a fixed rate because repayments can fall with interest rates
- You will usually pay application and⁄or arrangement fees
- If the loan is redeemed during and in some cases for a short while after, a penalty fee of several months' repayments is payable
Some capped rate mortgages have a collar. This means that the lender sets an interest rate below which the mortgage cannot fall. These may offer a better capped rate but if the interest rate falls below the collar rate then you do not benefit.
A discounted rate gives you a guarantee that for a period of time your interest rate will remain at a fixed percentage below the variable rate. Therefore, if the current interest rate is 7% and your rate is discounted by 2%, if the interest rate were to be increased by 1% then your rate would be 6%.
Advantages:
- Gives a reduced repayment over the period of the discount
- Repayments will reduce with interest rate falls
Disadvantages:
- Repayments will rise with interest rates
- May have to pay application and⁄or arrangement fees
- Usually a penalty payment of several months' interest if redeemed during or shortly after discounted period
Some lenders offer cash back. This is an incentive payment to the borrower, paid on completion of the loan.
Advantages:
- Can be very useful, especially to cover moving costs and any work or redecoration that may need doing.
Disadvantages:
- If the mortgage is redeemed within a preset period, some or all will have to be paid back to the lender.
With lenders coming up with ever more innovative products they are becoming even more diverse. Here are two examples:
Instead of there being a period of say a fixed rate then going to the standard variable rate there may be stepped rates. This could be 2 or 3 fixed rates stepping up before the standard variable rate applies. For instance a mortgage may have a fixed rate of 5.5% for the first year, then a 6.5% rate for another year and then after that the variable rate would apply.
This could also apply to stepped rates for capped or discounted rate products. In some cases the product may be more than one, for example, rixed rate for one year followed by a discounted rate for another year and then the standard variable rate.
It is possible to get products that are a combination of two rates. For instance you may be able to fix 50% and have the other 50% at the variable rate. The fixed rate would apply for a period of time before the full mortgage is at the variable rate.
› Types of Repayment
1. Capital and Interest Repayment
The payments on this type of mortgage are usually paid monthly. The payments include two elements, which are repayment of the capital you have borrowed (i.e. the mortgage loan) and the repayment of the interest on the loan.
The monthly payment is calculated taking both the payment of the capital and interest into consideration. From this a monthly figure is calculated. The repayment is recalculated every time there is a change in interest rate. This would not be the case with some of the special mortgages.
In the early years most of each payment goes toward paying the interest and a smaller part goes toward paying off the balance of the loan. As time elapses then more of the payment goes to paying off the capital and in the last years nearly all goes to paying off the balance of the loan.
The size of the payment you make each month is dependent on the size of the loan, the number of years the mortgage is taken out over and the interest rate.
The lender may insist that you take life cover that will pay off the mortgage in the event of death. If not it is advisable to consider it as a precaution in any event.
2. Interest Only (Endowment, ISA, Pension)
An interest only mortgage is quite simply repaying monthly the interest on the loan. The capital is repaid to the lender at the end of the loan period and not during, as with a capital and interest repayment mortgage.
The lender in most cases will grant this sort of loan on the condition that you have an investment plan that will repay the capital at the end of the loan period. It is your responsibility to ensure that one is in place and that it will meet the repayment of the loan in full when it is due.
At the end of the period of the mortgage the lender will demand repayment of the capital. If you cannot repay the capital at that time the lender will take steps to recover it. This could lead to you having to sell your home to repay it.
The three main savings plans that are acceptable to them are:
- Endowment (sometimes referred to as low cost endowment)
- Individual savings accounts (ISA)
- Pensions
Endowment policies have life cover built in that pay the mortgage off in full should you die before the mortgage is repaid. With ISAs and pensions the lender may insist on life cover being taken out and if not it is advisable to consider it as a precaution.
› Insurance
Insuring You and Your Home
It is your responsibility to ensure that all necessary forms of insurance relating to you and your home are in place.
As well as buildings and contents it is advisable to insure against events that could affect your ability to meet your mortgage payments. It is important that you consider insurance cover such as mortgage protection plans. These cover loss of income due to accident, sickness and unemployment. They can usually be covered collectively or individually and are also known as ASU (accident, sickness and unemployment) policies.
You should also consider the consequences of premature death and critical illness, on yours and your family's ability to meet mortgage and other financial commitments.
Why do I need it?
Insurance pays out when an unpredictable event causes a loss. You need insurance whenever:
- The law says you must have it. For example, if you drive a car, you must be insured.
- An event could happen to you and you would not be able to afford the loss, for example, if a tile fell from your house and injured someone who then claimed thousands of pounds for their lost earnings
- If an event happened, people who are dependent on you could not bear the loss, for example, if you died and your children needed the financial support you had previously given
In some cases, the state provides insurance by, for example, paying incapacity benefit if you can't work due to illness, or bereavement benefits to a widowed husband or wife. But state benefits are low and you usually have to pass a number of tests before qualifying for them.
Often a scheme at work provides life insurance. Check that the cover is enough for your needs. A scheme at work might also provide some health insurance, such as income protection insurance or private medical insurance.
What types of insurance are there?
You can protect yourself against unpredictable risks by taking out insurance. There is almost no limit to the risks you can insure against, but the most common types of insurance are listed below.
- General Insurance
Including car insurance, home insurance, travel insurance, private medical insurance, accident insurance and sickness insurance - Life Insurance
Including whole of life insurance, with profit bonds, unit linked bonds, income and growth bonds, endowment policies, maximum investment plans or any other life insurance, which builds up a cash-in value - Term Insurance
For example, lump sum term insurance including mortgage protection policies and family income benefit
For the purpose of protecting your home and mortgage the following are the insurances that you should give serious consideration to.
- Buildings Insurance
Pays the cost of repairing or rebuilding your home if it is damaged by unforeseen events, as detailed in the insurance policy. - Contents Insurance
Covers the cost of replacing possessions lost or damaged due to unforeseen events, as detailed in the insurance policy. - Accident, Sickness, Unemployment
Pays out a regular amount for a limited time, a year for example, if you can't work for health reasons or redundancy. Can be used to cover your mortgage payments. - Income Protection (also called permanent health insurance)
Replaces part of your income if you can't work because of long-term illness or disability. Often this is a type of general insurance but if it builds up a cash-in value, it is based on an investment-type life insurance policy. - Critical Illness Insurance
Pays out if you are diagnosed with a life-threatening condition, such as cancer or heart attack
This insurance pays out to cover loss of earnings in the event of accident, sickness or unemployment, either for all of these unforeseen circumstances, individually or any combination of them.
It is a requirement that both intermediaries and lenders give customers information about MPPI. This is in response to the government's wishes that an improved safety net is put in place following the review of Income Support for Mortgage Interest (ISMI).
The result of the review is that this benefit will not be paid until after 39 weeks (9 months) from when the claim is made, for loans taken out after 1st October 1995. Due to the way the payments are calculated (according to a 'standard interest rate' set by the government) the actual rate being paid by you may be greater.
It is important to note that eligibility for this benefit is assessed by the Benefits Agency Adjudicators. DSS estimates that only about 20% of claimants qualify for ISMI. It should not, therefore, be assumed that qualification is assured.
Equally it is important to get advice to ensure that your own circumstances meet the criteria for benefiting from these policies in the event of a claim. As well as looking at any existing arrangements with employers or other policies that may have been taken out already and to assess any savings that could be used to tide you over a prolonged period of reduced or zero income.
What to Check Out
Does it meet your needs?
- What risks, items and events are covered?
- How much will be paid out if you claim (for example, the full cost of replacing the item, its second-hand value, no more than a set cash sum, and so on)?
- What's not included, for example, claims due to health problems you already have, possessions not under lock and key, a home left empty?
- Are there any special features you want to be included?
- Note any 'excesses' (the first so many pounds of a claim that you must pay yourself). Often agreeing to pay a larger 'excess' means you pay a lower premium.
Cost
- Compare premiums for a year (or a shorter period if relevant)
- Premiums may vary with where you live, your job, your car, the size of loan to be protected, and so on. Make sure premiums are all quoted on the same basis.
- Is insurance premium tax (IPT) included?
- is there a saving if you pay by direct debit? Do you pay extra if you pay monthly rather than yearly?
Your Commitment
- How much must you pay?
- Do you pay monthly or yearly?
Flexbility
- Does cover stop immediately if you miss a payment or is there a period of grace?
- Do you get some of your money back if you cancel the policy?
- Do you lose some cover, for existing health problems, say, if you switch to another insurer?
Risk
- If you buy insurance over the internet, it may be less easy than other methods to find out where the insurer is based. If things go wrong you may not be so well protected with an insurer outside the UK.
- If you are not honest with the insurer, your policy may be declared void and your claims refused.
Review
- Review when you renew to check it's still good value.
There are two types of life insurance: investment-type and term insurance.
Investment Type Life Insurance
Investment-type life insurance pays out if you die and if you don't (with the exception of whole life insurance). It may sound ideal but investment-type policies cost a lot more than protection-only insurance. Usually, it's best to keep your insurance and investment needs separate.
If you want investments, consider the full range of products (not just life insurance), which might meet your circumstances and needs.
These are all investment-type life insurance:
- Whole-of-life insurance
- With-profits bonds
- Unit-linked bonds
- Income and growth bonds
- Endowment policies
- Maximum investment plans
- Other life insurance which builds up a cash-in value
What to Check Out
Does it meet your needs?
- Do you want income, growth or both from your investment (i.e. the focus is investment, not insurance)?
- For how long are you prepared to invest? Will you need to get at your money early?
- Part of your premiums pay for life cover - do you need this? If not, other investments might give you a better return. If you do, check whether separately buying term insurance plus other investments would be a better deal.
Cost
- How much must you pay in total over the life of the policy?
- How are the charges taken?
- Research shows that charges are one of the most important factors to check out.
Your Commitment
- How much must you pay, when and how often?
- If the policy requires regular payments, can you stop and start them without stopping the policy?
- Can you vary the amount you pay?
Flexibility
- Can you vary the amount you pay and even stop premiums for a while?
- Can you transfer your policy to another provider?
- What charges are deducted if you stop the plan early or transfer it to another provider?
Return
- Does the provider pay tax on the investments underlying the policy? (If so, bear in mind you can't reclaim this tax).
- Check if you will have to pay tax on amounts the policy pays out.
- Given your personal tax position, is this a suitable policy?
Warning: Do not rely on past investment performance
Risk
- Can you choose how your money is invested?
- Some investment funds are riskier than others. Is there a fund matching the level of risk you are happy to take?
- Can you alter the way your money is invested during the lifetime of the policy? Is there a charge for doing this?
- If you choose a with-profits policy, are you happy with the financial strength of the company?
- If you are drawing an income from the policy, how likely are you to get your capital back in full?
Review
- If you are using the policy to meet a specific savings target, for example, to pay off your mortgage or pay school fees, check regularly that your savings are on track and, if necessary, you may need to think about increasing the amount you save.
Warning: Check what charges are deducted if you stop the plan early or transfer it to another provider. Make sure you understand how a with-profits policy works before you invest.
If your main concern is protecting your family or other dependants, term insurance is often the cheapest way to buy all the cover you need.
Term insurance pays out if you die within a set period of time (the 'term'). If you survive the term, it pays out nothing. You might set the term at, say, the number of years until your children are financially independent, or the number of years remaining on your mortgage. It is not an investment; it is a low cost form of life insurance.
Types of term insurance:
- Lump sum term insurance (including mortgage protection policies)
Term insurance for a fixed term, for example, 10, 15, 20 years, and only payable if the event (i.e. death) occurs within that time (also called protection-only life insurance) - Family income benefit
Family Income Benefit (FIB) pays a monthly income to the beneficiaries in the event of death of the person(s) who are insured.
What to Check Out
Does it meet your needs?
- Can you get the amount of cover you need? There may be a maximum or minimum.
- What type of policy do you want? For example, family income benefit (a policy which pays out income rather than a lump sum), increasing policy (where cover and premium rise over the years), renewable policies (which let you extend the original term).
- Check for exclusions. In other words, when the policy won't pay out. For example, most do not cover death due to alcohol or drug abuse. You might not be covered while taking part in risky sports. If your health is poor when the policy starts, some causes of death might be excluded or you might be refused cover altogether.
Cost
- Typically, tables show the monthly premium for, say, £100,000 of cover for a man or woman of a given age for various terms (from, say, 10 to 30 years). Find the best premiums for the example which most closely matches you.
- Smokers usually pay more than non-smokers. The premium may be higher if your health is poor, or you take part in risky activities.
- The premium may be higher or cover refused altogether if your lifestyle puts you at added risk of contracting HIV/AIDS.
- Premiums shown are usually fixed for the whole term.
- You get tax relief on premiums if you take out life cover through a personal pension or a stakeholder pension. However the life insurance element will be taken as part of the maximum you can pay into your personal pension.
Your Commitment
- How much must you pay?
- Do you pay monthly or yearly?
Flexibility
- Does cover stop immediately if you miss a payment or is there a period of grace?
- Can you reduce or increase cover easily as your circumstances change? Are there extra charges for doing this?
Risk
- By paying extra, you can usually include 'waiver of premium'. It pays the premiums if you can't work because of a long-term illness.
› Important Notes
Fee Disclosure
It should also be noted that it is usual for the insurance companies who underwrite the policies recommended to you to pay a fee to the adviser. This is in recognition of the expertise, time, marketing expenses and administration in initiating the policy for you.
Compulsory Insurance
Some lenders' mortgage offers may contain a condition that you take out insurances such as buildings, contents, accident, sickness and redundancy. They may also insist that you take out with them. Please refer to your mortgage offer to check this and that if it is a condition, it is acceptable to you.
Confidentiality
We will treat all your personal information as private and confidential (even when you are no longer a customer), except where disclosure is made at your request or with your consent in relation to arranging your mortgage.
You have a right of access under the Data Protection Act 1998 to your personal records held on our computers and files.
Complaints
We have internal procedures for handling complaints fairly and speedily and we will tell you what these are. These will include establishing a set time for an initial acknowledgement to your complaint. We will tell you how long it might take us to respond more fully. If you wish to make a complaint, we will tell you how to do so and what to do if you are not happy about the outcome. We will help you with any queries.
FSA Useful Guides
The Financial Services Authority publishes useful guides on choosing a mortgage. These are available free through its website or by calling 0845 606 1234. The website also provides comparative tables to help you shop around.
View Our Reference Guide PDF
