13) SECURED AND UNSECURED LENDING Flashcards
Explain secured and unsecured lending
Lending is ‘secured’ when borrowing is against an asset to which the lender has the possession right if borrower does not keep up with repayments. eg mortgage lending
Unsecured lending is a kind of borrowing where the lender lends upon the upon promise of repayment by borrower and not secured against an asset. eg bank loan, credit card
How do capital repayment and interest-only mortgages work?
Repayment mortgage is when the borrower repays the capital borrowed as well as the interest on the capital over an agreed number of years at an agreed rate of interest, by making monthly repayments.
If no changes to int rates or repayments, then loan paid in time. Every repayment made up of capital element and int element. Repayments in the beg mostly cover int and less of cap, and towards the end cap element is more and int element is less. (If borrower dies, to be advised to have life assurance in place for repayment)
Interest-only mortgage where monthly repayments cover only the int on cap borrowed, so payments are a lower. At the end of the mortg term, the cap must be repaid, for which usually
- a funding scheme would have been entered into to save towards the capital repayment eg ISAs, pensions
- sufficient protection to repay if mortgagor shd die before the end of the term
What are the popular methods of funding repayment of interest-only mortgages?
Popular methods are endowments, ISAs and pensions to repay int-only mort, with life assurance arrangement to cover it should borrower die before the end of the term, or at the end of the term to pay off the original amount borrowed
Endowments to repay mortgages
See chapter 11 for details Can be Non profit With profits Unit linked Unitised with-profits low-cost with profits
What is pension mortgage?
Investment in a personal pension plan or stakeholder pension to repay mortg allows 25% of funds to be withdrawn - can be used to fund mortg repayment(avai from 55 yrs) - adv is pension contri are tax free, no IT or CGT (whereas endowment policy has both IT and CGT liabilities)
What could be some of the drawbacks of having a pension investment to repay morg?
1) LIFETIME ALLOWANCE: At present 25% of £1,073,000 allowed as tax free is £267,275 and may not be enough to repay mortg
2) MINIMUM PENSION AGE: Have to wait till 55 years of age
3) PROVIDER RESTRICTIONS: Not all providers may allow 25% pension funds withdrawal, although funds can be switched to a provider who does so
4) IMPACT ON INCOME: Using pension to repay mortg may reduce income in retirement
5) SEPARATE LIFE ASSURANCE: May be required for repayment in case of death before term
6) ASSIGNMENT: In an endowment policy, the lender is entitled to receive funds from the policy, but personal pensions and stakeholder pensions cannot be assigned to a third party such as the lender
Explain ISA mortgages
ISA accounts can be used as payment vehicles for repayment of an int-only mortg by using the lump sum saved, based on an assumed gr rate,
Benefits of ISA mort repayment
* funds growth free of IT and CGT,
* if fund gr exceeds assumed rates then mortg can be repaid early
Drawbacks - * no gr, not enough to repay,
* upon death of borrower, not enough saved to pay and may need separate life assurance to meet repayment
* govt annual limits on investment may not build suff sums for repayment
What are interest options for mortgage repayment?
1) Variable rate - payments rise and fall w int rate changes - budgeting difficulty
2) Discounted rate - IR is a discount from SVR - penalties for early reapyment
3) Fixed rate - fixed for a prd, then SVR - easy to budget, but arrangement fee, penalty for early repay, or switch to ano lender
4) Capped rated ‘cap & collar’- IR var but not over capped or below collar rates - can budget within parameters, ben if IR falls, can go down to collar
5) Base rate tracker - int moves up & down with base rate - note that IR is always above base rate
6) Flexible - can overpay, underpay, or take payment holiday (prearranged) - int calc daily, can go w current acc and offset mortg
7) Low start - begins with lower ini payments w no capital repayament, and later higher payments - suits borrowers who want low early repayments
8) Deferred interest - int payments deferred until later - if income expected to go up then suits, if high proportion of prop value is borrowed then danger of negative equity
9) CAT std - Charges, Access and terms - clearly stated limits on charges
Explain flexible mortgages
Mortg where
* int cal on daily basis * overpayments allowed w.out incurring charge * facility to underpay w.in parameters
Benefits - *if occasional or reg overpay, then overall int and mortg term reduces *if fin difficulty can reduce or suspend acc to agreed terms * can also borrow back previously made overpayments
Lenders may allow further borrowing of funds up to a previously agreed limit
Sometimes condition may be to use lender for parti insu product
Flexible mortg may come with fixed, capped or discount rated of int in the ini prd
CAT standard mortg
Charges, Access and Terms
Some of them are
- Variable IR no more than 2% above base rate and adjusted down within a month of base rate reduction
- Int calc daily basis
- No fee on variable loan and not more than £150 for fixed/capped loans
- Max early redemption charges apply for fixed or capped rate loans
- No charge for mortg indemnity guarantee
- all fees disclosed before commitment
Other terms - can choose repayment date in month, no more products to be bought from lender etc
What is shared ownership?
helps people with low incomes to become owner-occupier of a property, by not going thro conventional mortg
Borrower buys stake in property (eg 25%) and pays rent for the remainder. If they increase their share in the property by borrowing more, then mortg element of repayment becomes more (called staircasing) and rent element becomes less.
What are some insu products that cover mortg
- Accident, sickness and unemployment insu
- if death lump sum can be used for mortg repayment - Income Protection Insurance
- Pays outstanding loan amt to lender after proceeds of sale of property - Mortg Protection Insu
- Reg inc for INDEF PRD if beneficiary cannot work - Mortg Indemnity Guarantee
- Usu covers mortg payments for 2 yrs if cannot earn
What is equity release in mortgages?
In mortgage context, ‘equity’ is the amount remaining after all outstanding loan/s secured against it have been taken care of. Homeowners with no or little mortgage can release some of this equity in order to provide capital or supplement their income.
eg lifetime mortgage, home income plan, home reversion plan
How does lifetime mortg work? (It is an equity release mortg)
Lender lends usu up to 55% prop val, dep on borrower’s age - int fixed but not term, hence the name - int or cap is not gen paid back, but added to loan (rolled up). If borrower dies or moves, prop sold and lender is paid and rest if remaining goes to borrower or their estate.
Lenders provide ‘no-negative-equity’ promise, so what is owed is not more than value of prop.
Borrower can also draw down - max lending limit agreed, and borrower draws lump sums (with min sum agreed) whenever reqd. Int only on ‘borrowed sum’ is accrued, so borrower has control on amount borrowed.
How does home reversion plan work? (It is an equity release mortg)
Home reversion plans involve home owner selling all or a percentage of prop to scheme provider, home owner lives in prop rent-free/with nominal rent until death or moves, at wh point prop is sold - owner rec their percentage of proceeds, rest to scheme provider
