Guide for 1st Time Buyers
Buying your first property is a daunting prospect. With thousands of different types of mortgage to choose from and uncertainty over the future of UK house prices, it is small wonder that the percentage of first time buyers fell by 7 per cent in 2006 to 30 per cent of the market, its lowest level for 26 years.
But first time buyers are essential for the health of the property market as without new buyers buying in at the bottom, the property market could seize up.
This has not happened to date as buy-to-let investors have filled the gap, but this is not a healthy state of affairs and is unsustainable over the long term.
This guide gives an overview of the different types of mortgages on offer, the costs you can expect and the decisions that you will need to make when making your first purchase.
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How much can I afford?
As a single first time buyer earning £35,000 a year, you could borrow £105,000 on a 3 x single income basis. A couple with a joint income of £70,000 could borrow 2.5 times this, giving them £175,000, but in recent years with soaring house price inflation, some lenders have lent up to 6 or 7 times borrowers' income. Some lenders are also willing to lend you more if you can put down a large deposit.
However, since the credit crunch of 2007 and the Northern Rock debacle, lenders have started to apply stricter borrowing criteria and those with poor credit records may have difficulty in getting a mortgage at all.
Buyers are normally expected to put up a deposit of 5-10 per cent of the purchase price, although some lenders will allow you to borrow 100-125 per cent of the purchase price.
But this is risky as this puts you into negative equity from the start and if house prices don't rise rapidly, you could remain in this position for many years.
However, there's another reason why it is advisable to stump up a cash deposit. A Mortgage Indemnity Guarantee or MIG might be required by the lender if you borrow a high percentage of the property's value (known as loan to value, or LTV).
An MIG is an insurance policy which you, the borrower, have to pay for, but which benefits the mortgage lender should you default on your mortgage payments.
So MIGs are best avoided, although a few lenders including Nationwide and Cheltenham & Gloucester don't charge for MIGs.
Stamp duty is charged on all property purchases in excess of £125,000 (£150,000 if in a disadvantaged area) as follows:
- Up to £125,000: 0 per cent
- £125,000-£250,000: 1 per cent on the entire cost of the property
- £250,001-£500,000: 3 per cent
- £500,000 and above: 4 per cent
Clearly, this means you need to avoid agreeing a purchase price which is just over one of the thresholds mentioned above.
This can be done by agreeing to pay a lower purchase price in return for paying for certain fixtures and fittings separately in order to keep the official purchase price below the threshold.
But don't overdo this, as the taxman could object to any deal which is not a genuine cash transaction for a reasonable number of items which you agree to pay for separately.
Repayment or interest only
There are two ways of repaying a mortgage: repayment and interest-only. Let's look at the most popular method, repayment, first.
A repayment mortgage is exactly what is says on the tin: over a typical 25-year mortgage term, you repay the amount you borrowed - the capital, plus an element of the ongoing interest on a monthly basis.
As long as you keep paying the required amount each month, you will have paid off your mortgage in its entirety by the end of the mortgage term.
An interest-only mortgage means your monthly mortgage payments are around 30 per cent lower than those for a repayment mortgage. This is because you are only paying the interest on the mortgage and none of the capital (the original amount borrowed).
Monthly repayments on a £100,000 mortgage at 5.85 per cent would be:
- interest only: £485.21
- repayment: £632.18
Source: Halifax November 2007
The lender expects you to pay off the capital of an interest only mortgage by saving via an ISA, endowment or pension to build up alump sum which will pay off the capital at the end of the mortgage term.
Which mortgage is right for me?
Fixed, tracker, discount, capped, offset or standard mortgage? These are just some of the different types of mortgage available in the UK mortgage market.
Choosing the right type of mortgage is down to your view on future interest rate movements, if you are on a tight budget, if you have a fluctuating income and your future salary potential.
Can I cope if interest rates rise?
It's impossible to predict where interest rates are heading and even the experts sometimes get it wrong. So you need to check that you could still pay your mortgage if interest rates rose to, say, 10 per cent.
While this is unlikely in the near future, remember that base rate soared to 15 per cent in 1990, forcing homeowners to pay interest at up to 17 per cent which resulted in 75,000 homes a year being repossessed in the early 1990s.
Monthly cost of a £100,000 repayment mortgage:
- 6 per cent: £644.30
- 7 per cent: £706.77
- 8 per cent:£771.81
- 9 per cent:£839.19
- 10 per cent:£908.70
A 1 per cent increase on a 5 per cent mortgage increases your repayments by 20 per cent! Moral of the story? Be careful about how much you borrow, however tempting it is to borrow that little bit extra. And if you can't live with the worry of further interest rises, consider a fixed rate deal.
Early repayment charges?
Most fixed, discounted, tracker and capped mortgages levy early redemption charges (ERCs) if you to move to another mortgage or a different lender before the end of the mortgage term.
That said, there are some fixed rate deals without ERCs, but they will generally be charged at a higher rate than fixed rate deals with ERCs.
Some lifetime tracker deals also come without ERCs, so you don't necessarily have to put up with a standard variable rate mortgage to avoid punitive early exit charges.
Most early redemption charges are based on a percentage of the original value of the mortgage (on a decreasing scale over several years), or a flat rate fee.
Endowment mortgages involve you saving via an endowment policy to pay off the capital of an interest-only mortgage. These were all the rage in the 1970s and 80s when salesmen, amply rewarded with generous commissions, persuaded millions of homeowners to take them out.
The returns on some of these endowment policies have been disappointing, leaving thousands of homeowners with shortfalls at the end of their mortgages.
Offset or current account mortgage?
Be aware that offset mortgages are only effective for those who have substantial savings of at least £30,000 to be offset. If you don't have this level of savings, an offset may not be appropriate for you.
You could also consider a current account mortgage. Similar to an offset mortgage, it links your current account, personal loans and credit card debt to your mortgage - all in the same pot.
This means that although you don't earn interest on your savings, your mortgage debt rises and falls to reflect the amount of savings you have in your current account.
Mortgage interest is calculated on a daily basis which means that you benefit immediately from any increase in your savings (and hence reduction in your debt).
Current account mortgage providers include The One account (Virgin) managed by the Royal Bank of Scotland, NatWest and Bristol & West.
The difference between an offset mortgage and a current account mortgage is that an offset separates your accounts into different pots, possibly making it easier for you to manage your finances.
By contrast, a current account mortgage lumps all your debt and savings together, which some people may not feel comfortable with.
With house prices way beyond the means of many first time buyers, some lenders will allow a parent or close relative to act as a'guarantor.'
This means you may be able to borrow considerably more than you would normally be able to based on your own income.
Guarantor schemes are often targeted at young professionals who have recently graduated, but who have strong future earnings potential.
People with certain learning disabilities may also be eligible for a guarantor scheme.
So a guarantor mortgage takes into account the income of the guarantor (who may be a parent or guardian) to boost the size of mortgage you can take out. Sometimes no deposit is required so that you can effectively obtain a 100 per cent mortgage.
The idea is that you assume responsibility for the payment of all the mortgage at some point in the future, so that the 'guarantor' can be released from their obligations.
It is advisable that all parties take professional advice before entering into these arrangements.
Can't afford to buy outright? Then shared ownership, with its combination of part-rent, part-mortgage, could be the answer.
The idea is that over time you build up a bigger stake in the property as your earning power increases.
The usual route for shared ownership is through housing associations (their rents also tend to be lower than market rates, allowing you to save more money).
o you can escape paying stamp duty if the purchase price is less than £125,000;o you can gradually increase your equity share of the property up to 100 per cent - a facility known as staircasing;o it is cheaper than buying outright.
The savings will be greater when interest rates are high because although your mortgage payments will rise, your rent will not. But when interest rates are low, the savings are less pronounced.
You are still responsible for the repair and maintenance of the property and if house prices rise rapidly you could find that you can't afford to increase your share of the mortgage.
Leasehold or freehold??
Most flats are sold on leasehold basis, with most other properties (usually houses) being freehold.
A freehold property means that the owner has full, unconditional ownership of the property.
A leasehold property means the owner doesn't actually own the land on which the property is built, which is owned by the freeholder to whom you have to pay a ground rent every quarter.
As the leaseholder you have the right to live in the property for a certain amount of time, usually up to 99 years, though 999-year leases are more common nowadays.
Needless to say it is far better and more straightforward to own a freehold, compared to a leasehold, property. However, for people living in cities, where many buildings are divided into flats, a freehold property won't be possible.
Leaseholders have to pay the freeholder a ground rent, and service charges for the repair and maintenance of the exterior of the building and the common parts (such as hallway, gardens, lifts and stairs).
These charges can be punitive and some freeholders are more conscientious than others about the upkeep of their properties.
Recent leasehold reform has enabled leaseholders to band together to buy out the freeholder, or if that is not possible, to for management companies to organize the repair and maintenance of the property themselves, although the freeholder still owns the building.
If you are buying a leasehold property, bear in mind the following:
You can obtain more information about buying the freehold by contacting the Leasehold Advisory Service:www.lease-advice.org
- few lenders will lend on a property where the lease has less than 75 years to run;
- check out the level of service charges and 'major works' bills over several years, as these can vary dramatically from year to year(external redecoration and roof works can be particularly expensive).
Conveyancing and surveys
Legal fees will be the most expensive. Budget for at least £500 + VAT for the cheapest fixed-fee conveyancing, but it could be much more depending on the complexity of the transaction.
There are two types of survey:
Home Buyer's Report: a limited report which is designed to satisfy the lender that the property is satisfactory for the purposes of thea mount of mortgage you want. These surveys can cost as little as £200-£500 but should not be relied on to identify structural defects.
Full structural survey: more expensive, but worth its weight in gold if it alerts you to major problems such as subsidence or dry rot,or enables you to negotiate a cut in the purchase price. Expect to pay at least £500+, depending on the size and nature of the property.
Thereafter, be prepared for the following costs:
- land registry report will typically cost up to £150.
- local authority search, depending on your local council, could cost up to £200..
- Two lots of money transfer fees (CHAPs payment) from your solicitor to the seller's solicitors (£25-£30) on exchange and completion
- removal firm fees
Before you commit to a house purchase, remember to factor in the ongoing costs of repairing and maintaining the property, council tax, and buildings and contents insurance.
- Never arrange your mortgage with an estate agent. It's fine to get a quote, but then visit a mortgage broker to find the best rates.
- Keep your cards close to your chest when dealing with estate agents, so you can negotiate on price
- Be prepared for a big financial hit in the first month as some lenders want a full month's payment in advance as well as to the end of the first month.
- Keep some rainy day money aside for other unexpected bills - something is bound to need replacing once you move in.
Last edited November 2007