I want to buy a property but I don’t have the money to do so. What do I do? Is taking out a mortgage the solution?
What is a Mortgage?
Put simply, a mortgage is a charge over property in favour of the lender. The lender will lend you the money required so that you can purchase the property, and will then take a charge over that property until such time as the debt is repaid in full. You will have to enter into an agreement with the lender which will set out the terms of the loan including, but not limited to, the interest payable on the loan and repayment dates. Upon repayment in full, the charge will be released and the agreement between you and the lender ends, at which point you will be the full legal owner of the property. If, however, the money borrowed is not repaid, the lender has the right to repossess the property from you.
The Mortgage Application Assessment: How much can I borrow?
This is a question that most people ask themselves when choosing a property to purchase. The lender will need to assess the borrower’s mortgage application. In doing so, the lender will focus on three key factors, sometimes known as the ‘three Ps’:
Person – is the lender legally able and willing to lend to the applicant?
Property – is the property suitable security for the required mortgage;
Purpose – is the purpose of the mortgage acceptable (e.g. house purchase, home improvement, capital raising)?
The assessment of affordability is the responsibility of the lender. This is calculated based on your income and outgoings. The value of the property that the lender will take as security for the lending will also be factored into the equation.
Until relatively recently, it was common practice for lenders to use income multiples as a guide to the borrowing capacity of the applicant (e.g. three times or four times the income of the higher earner plus the income or twice the income of the second earner) or a multiple of the borrowers’ joint income (e.g. three times the joint income of the borrowers).
Nowadays, although lenders may still use the income multiples as an initial guide, a full assessment of affordability is carried out as a matter of course. Lenders now may be prepared to take a more flexible approach in certain cases. An example of this may be where the applicant is on a professional career path. Such applicants could be considered good candidates for slightly higher borrowing as their incomes are more likely to rise in the relatively near future.
What if interest rates increase?
Recent times have seen extremely low interest rates. However, the average mortgage rate went up by 0.25% in November 2017 and it is predicted that rates will rise further from 0.5% to 0.75% very shortly in line with the Bank of England base rate.
It is for reasons like this that lenders need to assess the impact of potential interest rate increases on the borrower’s ability to maintain mortgage payments in the future when considering affordability. This process is known as a ‘stress test’. The lender will take into account market expectations when assessing the rate to apply for the purposes of the stress test.
Once you enter into an agreement with the bank or the building society, you will be bound to repay the lender, regardless of whether interest rates increase more than was anticipated. It is therefore very important to ensure that you will be able to afford repayments during the term of the mortgage even if interest rates increase.
Attitude to risk
When choosing a mortgage product you may opt for a ‘fixed rate’ product so that, for the duration of the term of the product, the interest rates applicable to your mortgage will remain unchanged, regardless of whether interest rates change. However, this may also mean that if interest rates were to fall, you would be paying more than if you go for the ‘variable rate’ product. With the fixed rate, you are also likely to be subject to early repayment charges in the event that you pay off the mortgage before the end of the term you initially agreed to.
Affordability and attitude to risk are therefore the key points to be considered by any borrower, always remembering that your home or property may be repossessed if you do not keep up repayments on your mortgage.
Suzika Santiago is part of ISOLAS LLP’s property and conveyancing team. She also recently qualified as a Mortgage Advisor obtaining the London Institute of Banking and Finance Level 3 Certificate in Mortgage Advice and Practice.
For any further information and advice on mortgages and any other legal matters please contact Suzika on email [email protected].
BY SUZIKA SANTIAGO