FOOL'S EYE VIEW
Making A Mess Of Your Mortgage

By Cliff D'Arcy
February 19, 2004

Here's how my dictionary describes a mortgage:

Mortgage (noun) - 1 a legal agreement by which a financial institution grants a client a loan for the purpose of buying property, ownership of the property being held by the institution until the loan is repaid. 2 the money borrowed, or the regular amounts repaid. 3 any loan for which property is used as security. (verb) to give ownership of (property) as security for a loan.

Also known as a home loan, secured loan, second mortgage, burden or millstone. The word is derived from the French words mort (dead) and gage (pledge or promise) - literally, a promise until death. Blimey, they don't tell you that when you're sitting in your local bank branch!

Mortgage lending is one of the cornerstones of banking. Generations grew up saving with their local building societies, which they later approached for home loans. However, since banks were allowed to grant mortgages following financial deregulation that began in 1979, they have come to dominate this industry.

And it's a great market to be in, because it's enormously profitable: banks are making huge profits, thanks to strong consumer demand for mortgages and other credit. Indeed, the UK's four biggest banks are expected to announce combined profits of over £25 billion for 2003!

One reason why mortgage lending is so profitable is that consumers are failing to shop around for the best deals. There are over 8,000 mortgages currently on offer in the UK, from over a hundred mortgage lenders, with some real bargains out there. Regrettably, most of us fail to put even a little bit of effort into finding better home loans, which means ongoing fat profits for the lenders.

Here are eight of the most common mistakes made by mortgage borrowers:

1. Mortgage monogamy madness

Although monogamy is an admirable trait in other relationships, it's positively harmful when it comes to financial products! Why limit yourself to dealing with a single lender, when there are so many eager suitors for your business? You'd get several quotes from tradesmen before choosing one, so you should do the same with your home loan.

If you're paying your lender's standard variable rate (SVR) - in other words, you're not benefiting from a reduced- or special-rate deal - you're making a big mistake. It's no coincidence that Royal Bank of Scotland (LSE: RBS) made a whopping £6.2 billion last year, because it has the highest SVR of the UK's 35 biggest lenders!

The best strategy is to become a 'rate tart', switching your home loan whenever you can do so without penalty. This approach will save you tens of thousands of pounds over the life of your mortgage.

Check out the latest deals in our Mortgage Centre.

2. Nasty stings in the tail

So, you've shopped around for a great home loan, perhaps to replace an existing mortgage. Good work, but watch out for steep redemption penalties, which sting you if you repay your loan early. The cheapest home loans come with strings attached, particularly those with fixed, discounted or capped rates. So, the headline rate may look attractive, but you could pay a hefty fine for settling your loan early.

This happened to me: a couple of years back, I was forced to pay the equivalent of ten mortgage repayments to exit a ten-year fixed-rate mortgage. The danger is that your short-term cherry could become a long-term lemon!

3. Second-rate investment products

If you choose to have an interest-only mortgage, you'll need to pay into some form of investment vehicle that will produce a lump sum to pay off your mortgage at the end of its term. However, you'd be mad to buy any investment product from your mortgage adviser. They've sold some right horrors over the years, such as ropey endowments and high charging managed funds.

For investing over the long term, we suggest you use an index tracker wrapped up in a tax-free ISA, which is a simple, low-cost way to benefit from stock-market returns.

4. Chancy consolidation loans

If you have other debts, such as credit and store cards, personal loans or an overdraft, your mortgage adviser may suggest rolling these up into your home loan. While this would reduce the interest rate you'd pay, you'd repay the debt over a much longer period, which may lead to a bigger interest bill overall.

What's more, this is a risky approach, because you could lose your home if you are unable to meet the larger monthly repayments. For most people, especially persistent over-spenders, consolidation loans are a bad idea.

5. 'Life-threatening' mistakes

When you apply for a mortgage, your lender will 'strongly recommend' that you take out life insurance to cover your loan. You don't need it if you're young, free and single, but it's essential if you have a partner and/or dependent children.

However, you'd be most unwise to buy life cover from your mortgage lender. My years of research suggest that their policies are normally three times as expensive as the Best Buys (I call this my Rule of Three). If you need life cover, shop around for it. Here's an article about my search for value-for-money protection.

Also, don't take out a single policy to cover two or more people - a so-called 'joint life, first death policy'. By buying separate policies, you can get twice as much cover for just a few pounds more. Here's how.

Your mortgage adviser or broker might suggest protecting yourself from ill health by buying critical illness and/or income protection insurance. These policies offer valuable cover, but it's quite difficult to compare them, because of widely differing terms and conditions. Your best bet is to go to a firm with specialist expertise in selling these products, where you should find the right policy at an attractive price.

Find cheaper life insurance here.

6. High-priced home insurance

Buying home insurance (cover for your buildings and its contents) from your mortgage lender is another big blunder, because it also falls under the Rule of Three. I've worked for the UK's biggest home insurer, which made a fat profit from policyholders who blindly bought cover from their mortgage lenders.

Mortgage lenders will make it 'easy and convenient' for you to buy their own cover, often including the premiums in your monthly mortgage repayments. But this is simply a cunning trick to make you forget that you're over-paying for this protection!

Once again, shop around for this cover and give your mortgage lender's products the thumbs down!

Get a lower quote here.

7. Costly mortgage payment protection insurance (MPPI)

MPPI, which covers your mortgage repayments for up to a year if you cannot work because of accident, sickness or unemployment, is another product that you shouldn't buy from your mortgage lender. Learn more about this hugely over-priced protection here and here.

Ignore the sales patter that "our tailor-made policy makes it easier to claim when you're sick or out of work" and get shopping around. Alternatively, build up an emergency fund of your own, say, three to six months' living expenses, and you can 'insure' yourself!

Get cheaper MPPI here.

8. Where there's a Will, there's a profit

Banks often talk their customers into drafting a Will that makes the bank the executor of the Will. This is a big mistake, because the banks charge staggeringly high fees to administer and wind up the estate of a dead person, which leaves less for the beneficiaries.

Although it's vital to have a Will if you have any worthwhile assets, especially if you have a partner or family, get it drafted by a reputable firm with specialist expertise in this area. For more on Wills, Probate and estate planning, read this superb guide from Mark Goodson, who is drafting my new Will.

Of course, there are many more mortgage mistakes out there, but that's enough for today!

More: Five Major Money Mistakes | Ten Things I Hate About Money | Another Ten Things I Hate About Money.

The author owns shares in HBOS, Britain's biggest mortgage lender.