20. Mortgage Repayment Methods

Question 1

Is a capital repayment mortgage guaranteed to be paid off at the end of term?

Answer 1

yes

Question 2

How are payments made up of capital and interest at start of term compared to the end with repayment mortgages?

Answer 2

More interest at start, more capital at end

Question 3

Bob has a loan of £60,000 over 25 years. His interest rate is currently 5% and he pays £354.78 in repayments per month. How much capital is he paying back monthly?

Answer 3

(Loan amount / 100)*Interest rate = Amount of interest paid annually
Annual interest /12 = Interest paid monthly
Repayment amount – monthly interest = capital paid back each month
Capital paid back each month * 12 = capital paid back annually

So,
(60,000/100)5 = 3,000
3,000/12=250
354.78-250=104.78
104.7812=1257.36

Question 4

In what ways do repayment mortgages usually allow flexibility? (4)

Answer 4

1. If interest payments decrease
   - allow you to carry on paying same so you overpay
2. Overpayments are usually allowed irrespective of rate changes
   - popular with those who get pay rises and want to reduce term
   - if situation changes you can usually revert back to lower amount
3. One off partial repayments
4. Reduced monthly payments
   - can be agreed if struggling but would extend term

Question 5

What are the main advantages of choosing a repayment mortgage? (3)

Answer 5

1. Debt reduction - you know it goes down over time
2. Guaranteed to be repaid
3. not reliant on investment performance

Question 6

What is the one main disadvantage of repayment mortgages?

Answer 6

Life cover is not included and needs to be arranged separately

Question 7

How do you calculate monthly payments for an interest only mortgage?

Answer 7

(Loan amount /100) * Interest rate = annual interest
Annual interest / 12 = monthly interest

Question 8

Who is able to give advice on interest vehicles?

Answer 8

Only qualified financial advisers

Question 9

Are I/O mortgages guaranteed to be repaid at the end of term?

Answer 9

No

Question 10

What used to be the most common Investment vehicle? What is it now?

Answer 10

before - endowments
now - stocks and shares ISAs

why = endowments previously underperformed and were not enough to pay off

Question 11

What must lenders do in relation to those choosing I/O?
1. Before the contract starts
2. During the term

Answer 11

1. Check they have a CREDIBLE REPAYMENT STRATEGY (vehicle does not need to be in place) and CLEARLY UNDERSTAND. Assess whether it is likely to work as a strategy.
2. Review at least once, with enough time to rectify

Question 12

What types of repayment vehicles are not acceptable?

Answer 12

Speculative ones, like relying on house price inflation, potential inheritance, windfalls and ad-hoc investment

Question 13

What is a ‘pure’ interest only mortgage? When might they be acceptable?

Answer 13

An I/O mortgage without a repayment vehicle in place

still can’t be speculative, only allowed in instances like eventual sale of the mortgaged property. but even then, the price of the house must already be enough to repay - only works on properties with low LTV

Question 14

In what instance is no repayment vehicle at all needed?

Answer 14

Retirement I/O mortgages

Question 15

What are the fca rules on allowing someone to switch contracts or changing the existing terms of their contract with a provider?

Answer 15

Allowed, so long as the loan is not increased by more than the cost of switching

Question 16

What are the main advantages of using I/O?(2)

Answer 16

1. Variety of investment products
2. Repayment vehicle can perform better than expected - possible to repay early

Question 17

What are the main disadvantages of I/O mortgages? (3)

Answer 17

1. No capital repaid during term - debt does not reduce
2. Risk of vehicle underperforming - not suitable for the risk adverse
3. Total interest payable is much higher than C/R

Question 18

What is ‘rest’ in relation to mortgage interest?

Answer 18

The frequency at which interest is calculated

Question 19

What is annual rest?

Answer 19

Interest calculated annually at start of the year. When you make repayments, they are not taken off the debt until the end of the year.

This way has the slowest debt reduction and most interest payable

Question 20

What is monthly rest?

Answer 20

Interest is calculated at the start of the month. Payments are taken from the debt monthly also.

Less interest than annual, more than daily

Question 21

What is daily rest?

Answer 21

Interest calculated daily. Payments deducted from debt immediately

Fastest debt reduction and lowest interest payable

Question 22

What type of customers would annual rest be particularly unsuitable for?

Answer 22

Those who wish to repay in lump sums - would be paying off a big chunk of mortgage., but the actual debt would not be reduced until end of year. They would be better off keeping the money in savings until the end of the year to earn interest on it and pay it off right at the end

Question 23

Does annual interest benefit the borrower or the lender more? why?

Answer 23

Lender, because it is easier to operate and the lender ends up getting more interest

Question 24

For those who just pay their regular monthly instalments (not those wishing to make overpayments) is monthly or daily interest best?

Answer 24

Neither, they would both work out exactly the same. Daily is better for those who wish to make ad-hoc overpayments

Question 25

What is the purpose of APRC?

Answer 25

Enables people to compare the true cost of borrowing between lenders

Question 26

Is the APRC likely to be higher or lower than the product interest rate? Why?

Answer 26

Higher - takes into account interest, plus any fees, as an annual percentage over the mtg term

Question 27

What assumptions are made when calculating APRC? (4)

Answer 27

1. Interest rate at start of the term will stay the same for the whole of the term
2. The borrower will make all payments on time
3. No life insurance premiums are included in the monthly payment
4. The loan will not be redeemed early

Question 28

What is the Total Charge for Credit (TCC)?

Answer 28

It is the method of working out what costs should be taken into account to calculate the APRC

Question 29

What charges are excluded from the TTC? (3)

Answer 29

1. ERC
2. Endowment/life policy premiums
3. Charges levied if the borrower defaults

Question 30

What costs and charges are included in TTC? (7)

Answer 30

1. Total interest
2. Arrangement fee
3. Lender’s conveyancing fees
4. val fees
5. higher lending charges
6. redemption fees
7. any compulsory insurance premiums

Question 31

What is a second APRC? when is it required?

Answer 31

Second APRC to reflect possible increases in rates.

Needed for variable rate, MCD regulated mortgages

Question 32

When calculating second APRC, what figures do we use in relation to the following:
1. Capped rates
2. Uncapped rates
3. Index linked (eg base tracker)

Answer 32

1, Assume rates rise to the cap at the earliest point
2. Use the HIGHEST RATE OF THAT PRODUCT OVER THE LAST 20 YEARS
3. Use the HIGHEST INDEX RATE OVER THE LAST 20 YEARS

Question 33

If an external reference rate is not used to calculate second APRC, what should be used instead? (3)

Answer 33

Highest value benchmark specified by:
1. FCA
2. Another competent authority
3. European banking authority

Question 34

How should APRC be displayed on financial promotions?

Answer 34

MORE PROMINENT than flat interest rate

Question 35

Are second APRCs needed for fixed rate mortgages?

Answer 35

no