With the growing prospects of rising house prices, historically low interest rates, increasing longevity and delayed retirement, more and more people are considering borrowing for longer.
Last year, some 20% of property buyers searched for long-term loans – up from 8% the previous year. Nearly 30% of first- time buyers, moreover, took-out mortgages in excess of 30 years, with a significant proportion arranging terms of 35 years or more. Even home movers are beginning to do likewise, where the numbers more than doubled (5% to 12%) in 2015. Overall, the proportion of purchasers organizing loans for longer than the ‘typical’ 25 year term has doubled during the past five years. Most lenders, therefore, will agree to 30 year terms, many to 35 years, and some to as long as 40 years.
So why the attraction of long-term mortgages? Put very simply, it brings down the cost of monthly payments, even though it might well end up costing more. For many, it can be the only way of getting-on to the housing ladder in the first place. The table below shows the respective figures for variable lengths of a £200,000 mortgage on the basis of an interest rate of 4% throughout the term.
As “affordability” has become the watchword of the lending industry over recent years, and affordability checks mandatory since April 2014, it sometimes works out that 25 and 30 year mortgages appear unaffordable, whilst 35 and 40 year terms transpire to be tenable. As can be seen from the figures above, however, lowering monthly mortgage payments does not normally result in overall savings. Additional interest payments can significantly outweigh lower monthly payments and reduce equity holding in the form of capital repaid.
Understandably though, the intention of many caught in the ‘affordability trap’ is to accept these terms and then remortgage or overpay at a later date. In this way, the 35/40 year mortgage might be the perfect product for those at the early stage of their career, when possible windfalls, predictable bonuses or probable pay rises promise to appear over the next five to ten years. These can then be used to ‘overpay’ the mortgage and thereby shorten the term over time. It might also suit those who have found their “Forever Home” – and have no foreseeable plans to move.
For all mortgages you will be subject to a ‘stress test’ under the affordability rules introduced a couple of years ago. Borrowers who seek two to three year fixed mortgages, which offer the most attractively low interest rates, need to show a generous cushion in their disposable income demonstrating their ability to repay their loan at higher rates.
Nevertheless, the length of mortgage is only one feature in funding a feasible financial deal. It is always advisable to go back to the basics of mortgage lending is selecting a suitable option.
Back to Basics
People’s lifestyle, family circumstances, job situation, geographical location, earning capacity and investment decisions are an ever-changing landscape. Not to mention house price volatility and inevitable fluctuations with interest rates over the longer term. What is important, therefore, is to remember the basics of assessing and arranging a mortgage. We would suggest five fundamentally linked factors.
1. How to much can you realistically afford to borrow and what is your likely loan to value?
Lending is offered via individuals affordability and is calculated for each individual or couple. Years ago when applying for a mortgage you could base it on three to four times your salary, now days the maximum a lender would will offer is five times your salary with an excellent credit score and no additional debt.
2. How long the term, and what type of mortgage?
As already intimated, the preferred term over which to spread loan repayment is a question of striking a triple balance between eligibility, expense and equity. Broadly speaking, the longer the mortgage, the greater the interest payments and the less the amount of capital. More important than length, perhaps, is the ‘mortgage deal’ you strike. Even with mortgages of 30 years or more, it is probable that several different mortgage deals can be arranged over that period. Those are normally between two to five years and reflect the prevailing levels of interest rates in the market.
With regard to type of mortgage there are, of course, two main instruments. First, the ‘repayment mortgage’ where the capital sum is paid-off regularly during the term. And second, the ‘interest only mortgage’, invariably structured to complement a separate savings or investment plan which will discharge the debt at the end of the term. Although the latter might produce a better return it requires disciplined saving and investment.
3. Which deal and what rate?
The most frequent forms of mortgage deal are:
A) Fixed: Where a standard rate of interest is applied to the loan for a given period of years and repayments are constant.
B) Tracker: Where the interest rate will be linked to a set percentage figure above the Bank of England base rate, and repayments will vary accordingly throughout the term.
C) Discount: Where a reduction on a certain interest rate, most commonly the lenders standard variable rate, is given. This could be an introductory term of two, three or five years, or might even be for the entire term of the mortgage.
Once the type of mortgage is determined then it is a matter of comparing mortgage rates from the range of providers. There now exist in abundance of online comparison tables and calculators to assist with the appraisal. Better still; get good advice from an expert.
4. What are the fees, and how much flexibility?
Upfront fees can vary from as little as £100 to as much as £5,000, so it is vital to check precisely what is charged. There are even some fee free deals on mortgages for first time buyers; while other lenders allow the fees to be included in the total mortgage loan. What matters is to factor in the fees when comparing alternative offers.
Possibly more important, is to examine closely the repayment conditions that are attached to the mortgage agreement. Some mortgage providers are very stringent in their terms, with severe penalties incurred for any departures from the agreed repayment schedule. This can relate to ‘over’, as well as ‘under’, payment. It is well worth checking, especially for longer term mortgages, whether monthly overpayments or occasional lump sums can be made without penalty. Conversely, a repayment holiday, without serious forfeit, might be necessary if momentarily times turn hard.
5. Can it be transferred or discharged?
On the one hand, it is worth ascertaining whether or not you can take your mortgage with you if you move house. If so, what are the costs involved; and if not, are there any early repayment fees or new application charges for a fresh mortgage? On the other, if your financial circumstances change and you wish to pay-off your mortgage early; or, alternatively, you want to switch to another mortgage deal during the term; are there any significant repayment charges liable? This is not always easy, so the terms and conditions, together with consequent costs should be scrutinized carefully.
Long term mortgages of around 35 and 40 years might just be make sense for some borrowers who are particularly “payment sensitive”, needing lower repayments in order to qualify for a larger loan amount, or who simply want the lowest possible payments for the longest time. It should also be remembered that the loan can be paid-off more quickly if the terms and conditions allow when the borrowers circumstances change. In this way, long term mortgages can be used as short-term budgetary solutions where overpayment facilities are available.
To end on a cautionary note, however, borrowers who intend to move and borrow more in a few years time should be wary of taking the ‘easy option’ of lower mortgage payments now. With interest rates at historic low levels, now is the ideal time to be repaying the mortgage as quickly as possible, not as slowly. Above all, moreover, do not forget the basics of mortgage borrowing outlined above – as well as seeking expert advice.
“He that wants for money, means and content is without three good friends”
– William Shakespear ‘As you like it’