The mortgage rate available to an individual determines his ability to purchase a home. For example, an individual purchasing a home valued at £220,000 with a 10 percent down payment will finance £198,000. If he qualifies for a 3.90 percent fixed rate 25-year mortgage, he can expect a monthly payment of £1,045.06. If the interest rate rises even 1 percent, he can expect to pay £1,159.01, an increase of more than £100 per month. As a good rule of thumb, one’s mortgage payment should consume less than one-third of his monthly income. Therefore, the mortgage rate determines the price that one is able to pay for his home.
The Bank of England sets the monetary policy for the country. The Monetary Policy Committee meets regularly to evaluate current market standards and make any necessary adjustments to protect the value of the British pound. The Bank of England sets the interest rate at which it loans money to other banks. Banks can then pass along these savings as lower interest rates that they can offer to their customers and still remain profitable. Currently, the Bank of England has set their office Bank Rate at 0.5 percent.
Naturally, several other factors are included in the final interest rate offered to an individual homeowner. An individual’s credit rating is a prime factor in this calculation. Individuals with an excellent credit rating are a good risk for banks. These individuals have a proven track record of repaying loans in a timely manner, and will receive a low interest rate. On the other side of the coin, individuals with a poor credit rating have a proven track record of not repaying loans in a timely manner. A lender considering such an individual for a mortgage knows that it will assume a high degree of risk that the loan will not be repaid, and will therefore offer a higher interest rate.
Fixed-rate mortgages offer the stability of a consistent monthly payment for the term of the loan. Most fixed-rate loans are two- or five-year term, though some lenders now offer ten- or twenty-five-year fixed rate loans. The offered rate remains the same for the term of the loan regardless of any changes in the Bank of England Bank Rate.
For fixed-rate mortgages with a two- or five-year term, the mortgage payment remains at the introductory rate for the initial term of the loan. After the initial term, the loan reverts to the lender’s standard variable rate for the remainder of the loan balance. This rate generally runs from 2 percent to 6 percent higher than the Bank Rate. While the standard rate is loosely based on the Bank Rate, the lender need not pass along interest rate decreases to the borrower over the life of the loan. The borrower may decide to shop around for a new fixed-rate loan once the initial term of his mortgage expires. However, it is essential to remember that some lenders charge a penalty if the mortgage is paid off at that time. Remember, lenders make their money on the interest paid by the borrower. Lenders make remarkably little money during the introductory period when the interest rate is low. They make the majority of their money when the mortgage converts to the lender’s standard variable rate. Carefully weigh any penalties against potential savings prior to refinancing a short fixed-term loan.
Fixed-rate mortgages with a ten- or twenty-year term are a better deal for individuals who do not wish to gamble on the interest rate market. While it is possible that interest rates will lower during the duration of the loan, it is also possible that they will rise. If the rates lower, the borrower can always refinance at the lower rate, assuming that his credit rating is sound. If the rates rise, the borrower can rest assured that his monthly mortgage payment will remain the same.
A tracker mortgage is available for short-term mortgages with a life of two to five years, and for long-term mortgages with a life of twenty-five years. Unlike a bank’s standard variable rate, a tracker mortgage is tied to a base rate, plus a certain percentage. For example, if the base rate is 4 percent, and the added percentage is 1 percent, the borrower will pay 5 percent on his mortgage. If the base rate rises to 5 percent, the borrower will pay 6 percent on his mortgage. However, unlike a bank’s standard variable rate, tracker mortgages are firmly tied to the base rate. If the base rate drops by a point, the borrower will see his interest rate drop by 1 percentage point. While tracker mortgages offer more security than a bank’s standard rate in that tracker mortgages guarantee that the borrower will receive rate decreases, these mortgages still pit the lender and the borrower against one another in a bet on interest rates. The lender is betting that the interest rate will continue to rise so that he makes money on the loan. The borrower is betting that the interest rate will stay low throughout the term of his mortgage so that he does not have to pay as much interest.
For individuals who wish to build a new home, self-build mortgages provide financing for the project. Self-build mortgages are structured differently than other mortgages to accommodate the cycle of payment association with new construction. Remember, in a self-build mortgage, the borrower is requesting large sums of money to build what will eventually collateralize the loan. The bank must loan the money on good faith that the home will be built accordingly. Traditional self-build mortgages pay in arrears, which means that the borrower must finance the initial stages of construction on his own or he must obtain bridge financing to cover construction costs until the traditional self-build mortgage is in place. An advanced flexible self-build mortgage will cover the construction payments as they occur, freeing up cash flow for the borrower. The typical stages of construction during which payment occurs are buying the land, laying the foundation, raising the walls, putting the structure under roof, and completion. Each of these phases can be quite expensive if the borrower needs to finance them prior to the self-build mortgage paying. One downside of the advanced flexible self-build mortgage is that the interest rate is generally higher than other mortgages.
Islamic law prohibits Muslims from paying or receiving interest on money that is borrowed or loaned. In the past, this prohibition has prevented many Muslims from owning property in the UK. Only the very rich could own a home, as the home would have to be paid for with cash. Now, several of the lenders in the UK are working on a form of financing that satisfy Islamic law and enable more Muslims to own their own homes. This Islamic financing is called a Halal mortgage. It contains two options that meet Islamic law – the Murabaha Mortgage and the Ijara Mortgage.
Prior to applying for a Halal mortgage, an individual must be certain requirements:
- 21 years old or older
- A resident of the UK, or living in the UK on indefinite leave
- The property purchased will be a main residence
- Full-time employment, or records for a minimum of two years of self-employment
- No bankruptcies of CCJs
- Minimum property value of £100,000
- Minimum finance value of £70,000
- Deposit of 20 percent or greater
The Murabaha mortgage is available for individuals who have the ability to finance a large portion of the value of the home they intend to purchase. It is a form of a deferred sale finance loan. The buyer must be able to pay at least 20 percent of the home’s value on the date of the sale. The buyer and the seller agree on a price for the home. The buyer then negotiates a mortgage directly with his bank. Unlike a traditional mortgage on which interest is paid on a monthly basis, the Murabaha mortgage only requires repayment of the capital. The bank buys the house from the seller for the negotiated asking price. It then loans a higher amount of money, interest-free, to the buyer. As the mortgage does not include interest, the total amount of the loan is considerably higher than it would be with a traditional mortgage, dependent on the repayment. The advantage of the Murabaha mortgage is that the house it titled in the borrower’s name on the day of the sale. Also, as there is no interest payments involved, there are no penalties for paying the loan off early.
The Ijara mortgage functions more like a lease-to-own situation. The buyer pays the twenty percent deposit for the home. The bank pays the negotiated selling price of the home. However, unlike the Murabaha mortgage, the bank retains ownership of the property in an Ijara mortgage until the total amount is paid off. In other words, the bank agrees to act as a landlord of sorts, chagrining a monthly rental fee until the mortgage and associated fees are satisfied.
Mortgage Fees and Costs
While the interest rate available to an individual comprises a large portion of the decision in choosing a type of mortgage, the borrower must also be abundantly clear on the fees and costs associated with each type of mortgage prior to signing any paperwork. Not all lenders will require that the borrower pay each fee, so it is necessary to know as quickly as possible what the total cost of the mortgage package will be.
The Stamp Duty is required for all home purchases. The amount of Stamp Duty owed at the time of purchase depends upon the selling price of the home. Currently, homes valued under £250,000 require no Stamp Duty for first-time buyers only. For all other buyers, Stamp Duty rates are as follows:
- on homes valued up to £125,000, there is no Stamp Duty
- on homes valued between £125,000 and £250,000, the Stamp Duty is 1 percent of the sale price
- on homes valued between £250,001 and £500,000, the Stamp Duty is 3 percent of the sale price
- on homes valued at £500,001 or higher, the Stamp Duty is 4 percent of the sale price
Arrangement fees are charged by lenders, to cover the administrative costs associated with creating the loan terms and conditions. Some lenders charge these fees up front as an application fee. This fee is nonrefundable, even if the mortgage is never consummated. Other lenders charge these fees at the time of closing, rolling them into the mortgage amount. In the first instance, the borrower stands to lose his arrangement fee if the mortgage does not materialize. However, in the second instance the borrower will pay interest on his arrangement fees until the mortgage has been satisfied.