Continuing further from the previous article Home loan or mortgage plan selection, let’s talk today about the options you have to repay your mortgage or loans.
Once you have decided to take a mortgage, you must select a plan for repayment.
You can choose to pay your mortgage back in the following ways:
• repayment;
• interest-only; or
• a combination of the above two
Let’s discuss them in detail:
Repayment (also called a ‘capital-and-interest’ loan)
Basically, your mortgage liability consists of 2 parts:
• The principle amount (or capital amount) that you borrow as mortgage or loan
• The interest that you have to pay on the above principle amount, over a period of mortgage term
The payments you make to the lender every month reduce the principle/capital amount you owe as well as paying the interest on the loan. So each month you pay off a small part of your mortgage.
It’s a very simple and crystal clear approach – you can see your loan getting smaller. If you make all the agreed payments on all the agreed timings, the loan will be fully paid off by the end of the mortgage term.
However, one thing to be noted here is that in the early years your payments will be mainly interest. The reason for this is that since your principle or capital amount is high and close to the actual borrowed amount, the interest that you have to pay will also be high. Hence the payments that you will make while repayment will mainly go towards interest repayment and remaining small portion will go towards principle/capital repayment. As you carry on making repayments, gradually the interest component will reduce and hence more money will be going to the principle repayment.
The reason for mentioning the above point is that if you want to repay the mortgage or move house during the initial period of your loan, you’ll find that the amount you owe won’t have gone down by very much.
Interest-only
As the name suggests, your monthly payment only pays the interest charges on your loan – you don’t reduce the principle/capital amount of loan itself. Because you’re only paying off the interest your monthly payments will be lower than an equivalent repayment loan. So, one major benefit is that your monthly repayment amount will be less.
But what this means for the principle/capital amount of mortgage loan? It means that you are required to pay the actual principle/capital amount of mortgage loan at the end of the mortgage term period.
Hence it becomes very important that you arrange some other way to repay the loan at the end of the term, for example, through an investment or savings plan.
Make sure you know from the beginning how you plan to pay off the principle/capital amount of your mortgage loan.
Here are a few examples that people follow:
• Save or invest regularly with well planned strategy– so you build up a good enough amounts that will pay off the loan at the end of the term. You should check the progress of the plan regularly. If it doesn’t grow as expected, you will have a shortfall and you’ll need to think about ways of making this up.
• Switch later to a repayment mortgage. This might be a suitable option if, say, your earnings are low now but you expect them to be much higher in future. However, because you’re putting off repaying the loan you will end up paying more interest and more in total for your mortgage over the term.
• Use a lump sum from somewhere else – say, an inheritance, or selling something such as another property or a business. This may be risky – for example, how sure are you that you will get an inheritance or what happens if your business fails?
• Sell the mortgaged house to pay off the principle/capital amount of loan. This is suitable only if you won’t 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.
Think very-very carefully about using an investment or savings plan to build up the money you need to repay the mortgage. Think about the riskiness of your job and hence your salary – for e.g. in 2000-2001, many people were fired from their technology jobs. The mortgage loans they took was based upon the assumption that their job and hence their salary will continue. However, when they lost their jobs, they were in a financial distress.
Thinking of making money from stock market to repay your loans is also very risky. Here is a very good article telling you how stock market investments fail even in the long term. An investment plan invests in the stock market and the value of your investment can go up and down. If you are not comfortable with taking this risk, think about a repayment mortgage instead.
Home loan or mortgage plan selection
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Continuing further from the previous article How Mortgage Work, in this article we will explore how should one approach to select a mortgage plan or a home loan scheme, depending upon one’s financial circumstances and repayment ability.
First things first: You are responsible for paying back your mortgage – think carefully about which repayment option will suit you.
You can choose to pay your mortgage back in the following ways:
• repayment – your monthly payment is split between paying off the loan (principal amount) and paying off the interest you owe on the loan;
• interest-only – your monthly payment pays only the interest charges on your loan, and you must arrange some other way to repay the principle loan; or
• A combination of the above two.
The standard mortgage term is 25 years, but you can choose a different term if it suits you and the lender agrees that you can afford it.
With a shorter term, you’ll have higher monthly payments but pay less in total. With a longer term, you’ll pay less each month but more in total.
Beware of having a mortgage term that continues past the age you retire unless you’re sure you’ll be able to afford the payments then.
How to get help on selecting mortgage or selecting home loan?
You can find mortgage advisers on the high street or online. Make sure they’re regulated by the FSA or are agents of regulated firms. This means they must meet certain standards set by FSA so you can get the advice or information you need to help you make an informed choice
One Important thing to note is that FSA does not regulate buy-to-let mortgages. More on buy-to-let mortgages in a later article.
Important things to think about before finalizing a deal:
How much can you borrow or afford to borrow?
To a larger extent, it is the responsibility of the lending firm to check about how much the borrower can afford. Only after a proper assessment of the repayment capability, a lender should quote a maximum amount it can lend to the borrower, after assessing the financial situation of the borrower.
Also, the borrower should be very careful while making a commitment for the mortgage or home loan he is taking. Some schemes may end up in a disaster for the borrower, if he does not understand the scheme properly. For e.g. some lenders offer a discounted rate to start with, but one should see if he will be able to afford the repayments when the discount ends?
Mortgage lenders have in the past offered to lend up to 3½ times your salary (before tax). So if you earn £50,000 a year, you could borrow £175,000.
If you’re buying as a couple, i.e. jointly with your partner, lenders would normally multiply your joint total salary by 2½. So say you earn £25,000 a year and your partner earns £15,000, you could borrow £100,000; or multiply the highest annual income by 3½ and add the second person’s annual income. So using the amounts above, you could borrow £102,500.
If you have other sources of money, such as bonuses, overtime or commission, lenders may include only half of this because it isn’t guaranteed income.
Recently it has become more common for lenders to make an affordability assessment when calculating how much they will lend you. Each lender has its own method, but generally they all try to calculate your disposable income, taking account of:
• your total income;
• any money you owe, such as existing loans and on credit cards; and
• household bills and living expenses
Important point to note:
Don’t get into the habit of overstating your income to get a very large loan because you could end up with a mortgage you can’t afford and could lose your home; you’ll also be committing fraud and could get a criminal record. Remember, Ultimately, it’s you who has the responsibility of the loan. So if anything goes wrong and found to be incorrect, you will be in trouble. Hence, act responsibly
First things first: You are responsible for paying back your mortgage – think carefully about which repayment option will suit you.
You can choose to pay your mortgage back in the following ways:
• repayment – your monthly payment is split between paying off the loan (principal amount) and paying off the interest you owe on the loan;
• interest-only – your monthly payment pays only the interest charges on your loan, and you must arrange some other way to repay the principle loan; or
• A combination of the above two.
The standard mortgage term is 25 years, but you can choose a different term if it suits you and the lender agrees that you can afford it.
With a shorter term, you’ll have higher monthly payments but pay less in total. With a longer term, you’ll pay less each month but more in total.
Beware of having a mortgage term that continues past the age you retire unless you’re sure you’ll be able to afford the payments then.
How to get help on selecting mortgage or selecting home loan?
You can find mortgage advisers on the high street or online. Make sure they’re regulated by the FSA or are agents of regulated firms. This means they must meet certain standards set by FSA so you can get the advice or information you need to help you make an informed choice
One Important thing to note is that FSA does not regulate buy-to-let mortgages. More on buy-to-let mortgages in a later article.
Important things to think about before finalizing a deal:
How much can you borrow or afford to borrow?
To a larger extent, it is the responsibility of the lending firm to check about how much the borrower can afford. Only after a proper assessment of the repayment capability, a lender should quote a maximum amount it can lend to the borrower, after assessing the financial situation of the borrower.
Also, the borrower should be very careful while making a commitment for the mortgage or home loan he is taking. Some schemes may end up in a disaster for the borrower, if he does not understand the scheme properly. For e.g. some lenders offer a discounted rate to start with, but one should see if he will be able to afford the repayments when the discount ends?
Mortgage lenders have in the past offered to lend up to 3½ times your salary (before tax). So if you earn £50,000 a year, you could borrow £175,000.
If you’re buying as a couple, i.e. jointly with your partner, lenders would normally multiply your joint total salary by 2½. So say you earn £25,000 a year and your partner earns £15,000, you could borrow £100,000; or multiply the highest annual income by 3½ and add the second person’s annual income. So using the amounts above, you could borrow £102,500.
If you have other sources of money, such as bonuses, overtime or commission, lenders may include only half of this because it isn’t guaranteed income.
Recently it has become more common for lenders to make an affordability assessment when calculating how much they will lend you. Each lender has its own method, but generally they all try to calculate your disposable income, taking account of:
• your total income;
• any money you owe, such as existing loans and on credit cards; and
• household bills and living expenses
Important point to note:
Don’t get into the habit of overstating your income to get a very large loan because you could end up with a mortgage you can’t afford and could lose your home; you’ll also be committing fraud and could get a criminal record. Remember, Ultimately, it’s you who has the responsibility of the loan. So if anything goes wrong and found to be incorrect, you will be in trouble. Hence, act responsibly
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How Mortgage Work
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How Mortgages Work
Whether you’re a first-time buyer of a home, moving to a new home or staying put and remortgaging (changing your mortgage plan, but not your home), this site can help you choose a suitable mortgage. You’ll find everything you need to know: how mortgages work, how you can work out what you can afford, and where you can go to compare mortgages.
Let’s start with the basics:
What is a mortgage?
A mortgage is like any other kind of loan, but specific to buying a home – you borrow money, and you pay it back with interest over a period of time. A mortgage is a loan to buy your home. You borrow money and pay it back with interest over a period of time (the ‘mortgage term’) that you agree with the lender – usually a bank or building society.
Seems like a simple loan, but it has one key difference: The mortgage loan is secured against your home so if for any reason you can’t repay it, the bank or building society can sell your home to get back its money. Hence, it’s a loan secured against your home.
How mortgages work:
If asked to list the steps in which the mortgage works, you will come up with the following list:
• You take out a loan amount (a GBP value) based on how much you can afford and the value of the property, for a length of time agreed between you and the lender.
• You are charged interest on the loan, usually based on the Bank of England base rate, which is reviewed monthly.
• You pay the mortgage back in one of three ways, repayment or interest-only or a combination of the two.
• You can choose different deals for your interest rate, such as fixed or discounted.
• If you've had financial problems in the past and are finding it difficult to get a mortgage, the Council of Mortgage Lenders (CML) has a leaflet that may help.
If you are new to mortgages
There are the following three important things to note when you take out a mortgage (especially for novice borrowers):
• Find the mortgage that suits you and your circumstances;
• Borrow an amount you can comfortably afford; and
• Plan for changes – interest rates can go up, your income can fall, or you could lose your job.
How to repay your mortgage
Basically, when you take a loan, you have two components to repay. One, the Principle Amount – i.e. the actual amount that you took from the lender and two, the interest that gets accumulated for your loan.
You can choose to pay your mortgage back in the following ways:
• repayment – your monthly payment is split between paying off the loan (principal amount) and paying off the interest you owe on the loan;
• interest-only – your monthly payment pays only the interest charges on your loan, and you must arrange some other way to repay the principle loan; or
• A combination of the above two.
The standard mortgage term is 25 years, but you can choose a different term if it suits you and the lender agrees that you can afford it.
With a shorter term, you’ll have higher monthly payments but pay less in total. With a longer term, you’ll pay less each month but more in total.
Beware of having a mortgage term that continues past the age you retire unless you’re sure you’ll be able to afford the payments then.
Whether you’re a first-time buyer of a home, moving to a new home or staying put and remortgaging (changing your mortgage plan, but not your home), this site can help you choose a suitable mortgage. You’ll find everything you need to know: how mortgages work, how you can work out what you can afford, and where you can go to compare mortgages.
Let’s start with the basics:
What is a mortgage?
A mortgage is like any other kind of loan, but specific to buying a home – you borrow money, and you pay it back with interest over a period of time. A mortgage is a loan to buy your home. You borrow money and pay it back with interest over a period of time (the ‘mortgage term’) that you agree with the lender – usually a bank or building society.
Seems like a simple loan, but it has one key difference: The mortgage loan is secured against your home so if for any reason you can’t repay it, the bank or building society can sell your home to get back its money. Hence, it’s a loan secured against your home.
How mortgages work:
If asked to list the steps in which the mortgage works, you will come up with the following list:
• You take out a loan amount (a GBP value) based on how much you can afford and the value of the property, for a length of time agreed between you and the lender.
• You are charged interest on the loan, usually based on the Bank of England base rate, which is reviewed monthly.
• You pay the mortgage back in one of three ways, repayment or interest-only or a combination of the two.
• You can choose different deals for your interest rate, such as fixed or discounted.
• If you've had financial problems in the past and are finding it difficult to get a mortgage, the Council of Mortgage Lenders (CML) has a leaflet that may help.
If you are new to mortgages
There are the following three important things to note when you take out a mortgage (especially for novice borrowers):
• Find the mortgage that suits you and your circumstances;
• Borrow an amount you can comfortably afford; and
• Plan for changes – interest rates can go up, your income can fall, or you could lose your job.
How to repay your mortgage
Basically, when you take a loan, you have two components to repay. One, the Principle Amount – i.e. the actual amount that you took from the lender and two, the interest that gets accumulated for your loan.
You can choose to pay your mortgage back in the following ways:
• repayment – your monthly payment is split between paying off the loan (principal amount) and paying off the interest you owe on the loan;
• interest-only – your monthly payment pays only the interest charges on your loan, and you must arrange some other way to repay the principle loan; or
• A combination of the above two.
The standard mortgage term is 25 years, but you can choose a different term if it suits you and the lender agrees that you can afford it.
With a shorter term, you’ll have higher monthly payments but pay less in total. With a longer term, you’ll pay less each month but more in total.
Beware of having a mortgage term that continues past the age you retire unless you’re sure you’ll be able to afford the payments then.
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