FOOL'S EYE VIEW
The Ideal Mortgage

By Cliff D'Arcy
July 29, 2004

When it comes to choosing a home loan, UK homebuyers (and homeowners looking to switch loan or lender) are massively spoilt for choice. There are around 8,000 different mortgages out there, which means choosing a mortgage that's right for you is a major challenge!

Unfortunately, one mistake that many borrowers make is not to look beyond the headline rate. Alas, the very lowest rates often come with some pretty stiff strings attached. There's not much point in choosing a special rate that is ultra-low in the first year or two if you're then locked into paying sky-high rates for, say, the next five years.

So, when looking for your next mortgage, make sure that you take these five factors into account:

1. No redemption penalty or tie-in period

Beware of mortgages that offer attractive short-term rates, but tie you in to a lender's standard variable rate for a lengthy period afterwards. I call these deals, "short-term cherries, but long-term lemons"! Without any lock-in period, you're free to move on to a better deal without penalty. If you do choose a mortgage with a redemption penalty, make sure the penalty ends at the same time as the special rate does. Otherwise, you may find yourself paying an unattractive rate for years to come.

2. No arrangement or completion fees

Some lenders charge arrangement fees when you apply for a mortgage and, sometimes, completion fees when you draw down your loan. These fees allow lenders to advertise lower upfront rates, but make back their money on the side. For example, a £500 arrangement fee on a £100,000 mortgage with a two-year special rate is equal to an extra 0.25% on the interest rate over those two years.

Be warned: lenders will advertise the special rate prominently, while tucking away these chunky charges in the small print. Make sure you look beyond the advertised rate, and get wise to extra fees!

3. No mortgage indemnity premium

Lenders are wary of lending you more than three-quarters (75%) of the value of your home. If you want to borrow more than this, some will charge you a MIP, also known as a Mortgage Indemnity Guarantee (MIG). This is an insurance premium that protects your lender if you default on your loan, but has absolutely no financial value to you. So, you pay the premium, but the policy only protects the lender!

These days, good lenders do not charge MIPs on mortgages up to nine-tenths (90%) of the value of a property, referred to as "90% LTV (loan to value)". So, if you have a 10% deposit or own at least a tenth of your current home, you should be able to avoid paying this charge, which can amount to thousands of pounds. Skip the MIP, because MIGs are pigs!

4. Interest calculated daily, plus flexible features

Some lenders collect your mortgage repayments throughout the year, but knock these off your loan only at the end of the year. In other words, your January payment isn't credited until the end of December, which means that you've given your lender a significant interest-free loan! These old-fashioned mortgages (there are still millions of them around) are called 'annual interest' or 'annual rest' loans.

Would you prefer a mortgage where your debt falls on the very same day that you make a repayment? If you would, choose a mortgage that calculates interest daily, as many modern mortgages do.

Another advantage of choosing a daily-interest mortgage is that many are also 'flexible' mortgages. These allow you to overpay, underpay, take repayment holidays, and withdraw lump sums if you have sufficient equity. Making regular overpayments and dropping in the odd lump sum (such as a bonus from work, redundancy payment, inheritance or other windfall) will dramatically shorten the term of your mortgage and slash your total interest bill.

5. Fee-free switching

Even though the hyperactive UK housing market is keeping lenders busy, still they cut each other's throats to tempt existing mortgage borrowers away from the competition. Re-mortgaging (switching lenders) is big business and accounts for a large slice of overall lending. According to the Council of Mortgage Lenders, it made up almost two-fifths of total lending (39%) last month, having peaked at more than half of total lending (51%) in May 2003.

If you're going to become a 'rate tart' by switching loan or lender every few years, it's worth finding out what incentives your new lender is offering. Many provide 'fee-free switching deals' by paying (or making a contribution towards) your valuation and legal fees. Typically, this is worth £500 or more, which you should factor into your calculations.

Finally, there are mortgages that offer all of the above features, but they come at a price: the rates you pay will be higher than the very lowest discounted, fixed, capped or tracker rates. Nevertheless, mortgage lenders will always make their money somehow. (This article shows you how to add up all the costs of your home loan.)

And remember: a merrier mortgage means a happier home!

More: View the bargains in our Mortgage centre.