Glossary of Terms

Mortgage

A mortgage is a sum of money borrowed from a bank or building society in order to purchase a property. The money is then paid back to the Lender over a fixed period of time together with accrued interest.

Types of Mortgage

There are essentially two different types of mortgage:

  • Repayment (capital and interest mortgage)
  • Interest only (ISA, pension or endowment mortgage)

Repayments

Your monthly repayments consist of repaying the capital amount borrowed together with accrued interest. On your annual mortgage statement, you will see that the outstanding balance decreases throughout the term.

Advantages of a repayment mortgage

  • At the end of the term, you are safe in the knowledge that the total amount of the debt has been repaid, assuming you have maintained your payments
  • Overpayments and lump sum payments into your mortgage account can be made, reducing both the interest and capital amounts repayable.
  • Life assurance cover is not always necessary in taking out this type of mortgage but is strongly recommended.

Disadvantages of a repayment mortgage

  • There may be financial penalties for making lump sum/overpayments into your mortgage account. In the early years of a repayment mortgage the majority of the monthly repayment is interest rather than capital.
  • If you have no life assurance cover in place and die before the loan is repaid, the mortgage will still need to be repaid. This may result in the property having to be sold to repay the debt owed.

Interest only

With this type of mortgage, each mortgage payment is only used to pay off interest. At the same time, the borrower takes out an alternative ‘repayment vehicle’ (method of paying off the mortgage) such as an ISA, pension plan or endowment policy. The most important fact about an interest only mortgage is that the monthly repayments do not repay any of the outstanding capital balance. As a consequence it is important that the payments are maintained into the repayment vehicle; otherwise it will not be possible to pay off the mortgage at the end of the term.

Advantages of an interest only mortgage

  • If the proceeds of the investment plan exceed the amount required to repay the mortgage, then this is received as a cash lump sum by the borrower.
  • Some plans are tax-efficient.

Disadvantages of an interest only mortgage

  • If the proceeds of the repayment vehicle do not achieve the amount expected, then there will be a shortfall. The borrower remains liable for any shortfall on the mortgage hence the outstanding balance will need to be paid off from other resources.

Various Types of Mortgage Interest Rates

Fixed Rate Mortgage

With a fixed rate mortgage the amount you repay the lender each month can be at a fixed interest rate for a specified period of time, regardless of changes to interest rate in the market place. At the end of the fixed rate period the rate will normally convert to the lenders Standard Variable Rate (SVR).

It is normal for lenders to charge up-front fees in the form of booking and/or arrangement fees. In addition lenders frequently apply an Early Repayment Charge (ERC) for fixed rate mortgages. This acts as a ‘lock-in’ making an often heavy charge for borrowers paying off their mortgage early. The ERC can sometimes last longer than the fixed rate or other ‘deal ‘period.

Capped Rate Mortgage

A capped rate mortgage is very similar to a fixed rate mortgage except that if the variable rate drops below the capped rate, the borrower will make payments based on the lower variable rate. However, should rates increase the payments will be ‘capped’ and will not rise over the capped rate. Again, as with fixed rates, up-front charges and ‘lock-ins’ are common.

Discounted Rate Mortgage

The Lender offers a discount on the Standard Variable Rate (SVR) for a specific period of time. As the discount is linked to the SVR, the borrower’s payments will increase, if rates rise - so there is no certainty in budgeting. However, should rates decrease, the borrower will benefit from lower payments.

It is still possible to have up-front charges for discounted products and an Early Repayment Charge is common.

Variable Rate Mortgage

Borrowers paying the Standard Variable Rate will have their payments increase or decrease as the lender adjusts the rate in accordance with market conditions

Tracker Rate Mortgage

This is a variable rate that is linked to the movement of a prevailing rate such as The Bank of England Base Rate or London Interbank Offered Rate (LIBOR). The pay rate will be a set percentage amount above the relevant base rate for a specified period of time and ‘tracks’ the movement on the base rate.

Associated Mortgage Fees

Higher Lending Charge (previously referred to as a Mortgage Indemnity Charge).

Where the amount borrowed exceeds a specific percentage of the property’s value (set by the lender) you may be charged a Higher Lending Charge fee by the lender. The lender uses this fee to take out insurance to protect itself against any losses incurred if the property needs to be taken into possession because of serious arrears. It is common practice for lenders to pass this charge on to the borrower.

As an example, the valuation is £100,000 and the mortgage loan is £90,000 the amount of loan above the 75% Loan to Value (LTV) is £15,000, the fee is a percentage of the £15,000. There are some important facts to understand about the Higher Lending Charge. It acts as a form of insurance for the lender not the borrower. This means that the lender can claim part or all of its ‘losses’ incurred repossessing the property from the insurance company providing the cover. Note that even after repossession the former borrower will remain liable for any sums owing (shortfall between selling price and mortgage outstanding plus arrears, lenders legal costs and any other charges applied to the mortgage) and can be pursued by the insurance company for payment at a subsequent date.

Booking Fee

A fee charged by the lender to secure the mortgage funds.

Arrangement Fee

Usually charged by the lender and can sometimes be added to the mortgage loan.

Valuation Fee

A fee payable to the lender who instructs a surveyor to inspect the proposed property that is being offered as security for the loan for the purposes of the mortgage For peace of mind it may be appropriate to obtain a ‘Housebuyers Report’ or a ‘Full Structural Survey’. These are more detailed than a lender valuation and they are produced on behalf of the applicant. They are more expensive than the lenders valuation.

Legal Fees

The solicitor fees include the work associated with Land Registry, Mining Search, transfer of mortgage funds amongst others.

Insurance

Lenders will insist that the property is adequately insured, with a suitable Buildings Insurance Policy, as it represents security against the mortgage debt. A buildings policy covers against storm damage, fire, flooding etc and relates to the fabric of the house or flat etc. It is normal for lenders to check that any policy arranged is adequate and a fee will sometimes be levied to check the policy, if the borrowers take a policy other than the one sold or recommended by the lender.

Contents insurance is optional but highly recommended.

Other Terminology

Adverse Credit

If a borrower has a history of poor credit usage then this is described as Adverse Credit. Poor Credit history can include County Court Judgements (CCJ), Bankruptcy, Mortgage arrears or any late payments on credit arrangements.

Arrears

This describes the amount the borrower is behind in their mortgage repayments schedule. The amount is usually measured in either pounds or months.

Bankrupt

A Corporation, Firm or individual who, via a court proceeding, is relieved from paying all debts once assets have been surrendered to a court appointed trustee.

County Court Judgements (CCJ)

This is an adverse ruling by a County Court against a person who has not satisfied their debt payments with their creditors. Once the ruling has taken place it will be recorded against the person’s credit history and will appear every time a credit search is done for the next seven years. If a person has a County Court Judgement against them it will have to be satisfied before they can get a mortgage. They will also find that the mortgages they can get will be at a higher interest rate. Default Failure of an individual to make payments on a mortgage at the correct time or to not comply with the mortgage companies requirements.

Your home may be repossessed if you do not keep up repayments on your mortgage.