Michelle Niziol, founder and managing director of Independent Mortgage Solutions, explains why a longer-term mortgage could get you onto the property ladder. It brings your monthly payments down but will cost more in the long run
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 online for long-term loans – up from 8% the previous year.
Nearly 30% of first-time buyers 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 from 5% to 12% over the year.
Overall, the proportion of purchasers organising 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 what is 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 overall. For many, it can be the only way of getting onto the housing ladder in the first place.
Affordability
As affordability has become the watchword of the lending industry over recent years, with more stringent affordability checks introduced in April 2014 under the Mortgage Market Review, 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 in the table on page 13, 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 if rates were higher.
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 much can you realistically afford to borrow and what is your likely loan-to-value?
Lending is offered subject to the borrower’s 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. Nowadays the maximum a lender would offer is five times your salary assuming you have an excellent credit score and no additional debt.
2. How long should the term be 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 overall but you pay back less capital each month.
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:
Fixed: Where a standard rate of interest is applied to the loan for a given period of years and repayments are constant.
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.
Discount: Where a reduction on a certain interest rate, most commonly the lender’s 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 exists an abundance of online comparison tables and calculators to assist with the appraisal, including the What Mortgage website. 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 the mortgage 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 hand, 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 scrutinised carefully.
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77,000 first-time buyers took a 35-year mortgage last year
One in four (26%) first-time buyers took out a 35-year mortgage in 2015, according to Halifax.
This is up from 16% eight years ago in 2007. Over the same period, the share of mortgages with a 20 to 25-year term dropped from almost half (48%) to three out of 10 (30%).
The annual Halifax First-Time Buyer Review estimates that the number of first-time buyers totalled 310,000 in 2015 therefore more than 77,000 opted for a 35-year mortgage.
The number of first-time buyers taking a traditional 25-year mortgage has fallen significantly by 55% in 10 years. In 2005, almost two-thirds (64%) of first-time buyers went for a 25-year mortgage compared to just 30% in 2015.
Virgin Money has fairly similar statistics. In 2015 almost six out of 10 first-time buyers (58%) took out a mortgage with a longer term than 25 years compared to one in four (25%) in 2005.
There are a number of reasons for this as Peter Rogerson, commercial director of mortgages at Virgin Money, explained: “We have seen house prices recover from 2007 and houses are becoming more unaffordable. More importantly, it is becoming difficult for borrowers to acquire a mortgage because of earnings versus house price rises. House prices are around nine times higher relative to average UK earnings compared to just over four times 20 years ago.”
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Conclusion
Long-term mortgages of around 35 and 40 years might 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.
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