Chapter 2

Question 1

A1) How do you find out a clients disposable income?

Answer 1

It is the difference between their income and their expenditure.

Question 2

What will a budgeting assessment allow you to do?

Answer 2

It will allow you to examine whether a proportion of income might be redirected away from a current area of expenditure to an area of higher priority.

Question 3

It is better to recommend a partial solution your client can afford, rather than…

Answer 3

a perfect solution that they cannot.

Question 4

A2) What is the first step to managing debt?

Answer 4

Working out how much money is coming in and how much money is going out.

Question 5

What is essential spending?

Answer 5

Housing costs, insurance, council tax, utilities, childcare etc.

Question 6

What is everyday spending?

Answer 6

Food, cleaning, transport, school etc

Question 7

What is occasional spending?

Answer 7

Clothing, entertainment, birthdays, holidays etc

Question 8

What are some tips which could help a client reduce their spending?

Answer 8

1) Consider making small cutbacks on non-essential items.
2) Check the Annual Percentage Rate (APR) on credit cards and loans - see pay them off sooner/shop around for a better deal.
3) Switching to a cheaper provider for: phones, electricity, gas etc..

Question 9

Priority debts include:

Answer 9

Mortgages, utilities and council tax.

Question 10

Debts of lesser importance include:

Answer 10

Credit cards, overdrafts and personal borrowing.

Question 11

Who should a client in debt reach out to first if they are struggling to pay?

Answer 11

The lender, as they may be able to set up an arrangement where the client pays smaller amounts over a spread out time.

Question 12

If there is a surplus of income each month and there are number of unsecured debts, which is the best route to go down for a client?

Answer 12

Getting a debt management plan (DMP.) This is an agreement between the creditors and the client on how the debt will be paid back. The client can sort this out with the creditors individually or they can use a debt management company which will negotiate with the creditors to establish an acceptable repayment plan.

Question 13

How does a debt management company work?

Answer 13

A debt management company will consolidate all of the clients debts into one monthly affordable payment after negotiating will the client’s creditors.

Private companies will charge a fee for their services, however their are free services available too.

All advisers must be properly licenced under the consumer credit acts 1974/2006.

Question 14

What us debt consolidation?

Answer 14

Debt consolidation means negotiating a new loan to repay an existing loan or loans, often with a lower interest rate and lower monthly payments.

Question 15

Why should advisers exercise great caution recommending debt consolidation plans to clients? (especially if it is secured on the client’s property.)

Answer 15

1) Companies that offer this service often charge high fees, including those for early repayment.
2) Even though the monthly payment might be lower, clients could end up paying more and more over time.
3) A client with a history of running up loans may simply continue to do so, and eventually put themselves in a more serious position.
4) In a worse-case scenario , if the loan is secured on their property they could lose their home if they default on their payments.

Question 16

B) What is a mortgage?

Answer 16

The security offered in exchange for a loan. When the security is signed over to the lender in exchange for the mortgage, this transfer of ownership is called the assignment.

A mortgage involving a property can involve the deeds of the property or many simply register a charge on the property with the Land Registry.

Question 17

Which are the main two ways in which a mortgage can be repaid?

Answer 17

1) Capital and interest repayment

2) Interest only repayment

Question 18

What is a capital and interest repayment?

Answer 18

This is where the monthly repayments to the lender include a sum to cover a contribution towards the repayment of the capital, plus a sum to cover the interest.

Over time as the loan is gradually repaid the interest reduces inline with the reducing outstanding capital.

Question 19

What is an interest only repayment?

Answer 19

It is where only the interest accruing on the loan is paid and the outstanding capital remains the same.

The objective with this type of loan is to repay it from another source at the end of the term.

Question 20

What is a capped mortgage?

Answer 20

The lender guarantees that the interest rate will not rise above a given level for a certain period of the loan.

Question 21

What is a cap and collar mortgage?

Answer 21

The lender guarantees that the interest rate on the loan will not rise above a given level (the cap). However, there is also a minimum rate below which the interest will not fall (the collar).

The two can be applied together, so rates are guaranteed to be between an upper and lower limit for a given period of time.

Question 22

What is a discount mortgage?

Answer 22

The interest rate charged for an initial period of the loan is reduced by a set percentage below the standard rate set by the lender.

Question 23

What is a Euro based mortgage (or other foreign currency)?

Answer 23

The interest and capital of the loan is designated in euros, usually to take advantage of lower interest rates.

This can result in gains or losses as the currency exchange ratee moves relative to Sterling.

Question 24

What is an equity-linked mortgage (aka a shared appreciation mortgage)?

Answer 24

The lender takes a stake in the equity of the property that has been purchased. The amount loaned, on which interest is charged is less than the amount advanced for the purchase.

On the sale of the property, the proportion of the lender’s equity stake is repaid to them. It is possible for the borrower to slowly accrue the lender’s equity stake over time.

Question 25

What is a fixed interest mortgage?

Answer 25

The interest rate charged remains fixed for a given period.

The borrower takes a risk that interest rates generally might fall below the rate charged, but in exchange have a known liability for mortgage interest over the fixed period.

These schemes often carry redemption penalties.

Question 26

What is a flexible mortgage?

Answer 26

Monthly payments can be varied if required and lump sum capital repayments can be made at anytime. As capital is repaid, this creates a reserve from which the borrower can withdraw cash up to the initial mortgage amount at any time.

If the borrower experiences any financial difficulties, they can use the reserve to meet future interest payments.

Question 27

What is an offset mortgage?

Answer 27

This is where a mortgage account and a current account are linked. Interest is charged on the net balance of the two accounts, so if money is kept in the current account the size of the mortgage is effectively reduced. Even the effect of a monthly salary going in can have an effect and reduce the overall interest payments.

Question 28

What is a tracker mortgage?

Answer 28

A variable rate mortgage where there is an automatic link built in, so the interest ‘tracks’ an index, usually the Bank of England base rate. It is designed to move as the index moves, usually after a period of 15 days.

Question 29

What is equity release?

Answer 29

Equity release allows clients (typically older, 60+) release the equity (cash) tied up in their home.

The products have no fixed term, and the clients can stay in their home for the rest of their lives or until they move into a long-term care facility.

Equity release schemes are either lifetime mortgages or home reversion plans.

Question 30

What is a lifetime mortgage (equity release)?

Answer 30

With a lifetime mortgage, the client is taking out a loan secured on the home.

1) a roll up mortgage: the client gets a lump sum or regular income and is charged a monthly or year interest which is added to the loan. The original amount borrowed + the rolled up interest is what is repaid when the home is eventually sold.
2) a fixed repayment lifetime mortgage: the client gets a lump sum but doesn’t have to pay any interest. Instead, when the home is sold, they pay the lender a higher amount than they borrowed. That amount is agreed to in advance.
3) an interest only mortgage: the client gets a lump sum, and pays a monthly interest on the loan, which can be fixed or variable. The amount originally borrowed is repaid when the home is eventually sold.
4) a home income plan: the money borrowed is used to buy a regular fixed income for life (an annuity). The income is used to pay the interest on the mortgage and the rest is the client’s. The amount originally borrowed is repaid when the home is eventually sold.

Question 31

Some lifetime mortgages include a shared appreciation element. What is this?

Answer 31

It is where the lender has a share in the value of the home.

Question 32

What is a no negative equity guarantee?

Answer 32

If there is not enough money left from the sale of a house to pay of the loan, the beneficiaries/client would have to repay any extra above the value of the home. This guarantee promises that the client will never have to pay back more than the value of the home - even if the debt has become larger than this.

Question 33

What is a home reversion plan?

Answer 33

The client sells a all or part of their home in exchange for a cash lump sum or regular income (or both). The home, or part of it, then belongs to the home reversion provider, but the client is allowed to carry on living in it under a lease until they die or move into a long term care facility.

Because of this, the client will usually only get between 20% and 60% of the market value of their house. The older they are when they start the scheme, the higher the percentage will be.

Question 34

What are the two home purchase plans available for Muslim clients who wish to comply with Sharia law?

Answer 34

Ijara: the monthly payments made towards buying the property are held by the firm and used to buy the home at the end of the agreement.

Diminishing musharaka: each payment made towards buying the property buys and extra slice of the firm’s share. As the client’s share increases, the firm’s share gets smaller and so does the rent paid for the use of the firm’s share/

Question 35

What is a sale and rent back agreement?

Answer 35

Some companies offer help to clients with financial difficulties by buying their home and renting it back to them for a short period of time.

Question 36

What is there to look out for with a sale and rent back scheme?

Answer 36

1) clients will normally be paid less than the full market value of their home.
2) clients should check how long that can stay in their home as their rental agreement may not be renewed, so they could have to leave after the initial term comes to an end.
3) they could still be evicted if they breach the terms of their tenancy, for example if they fall behind with their new rental payments.
4) if the firm buying the home gets into financial difficulties, the property could still be repossessed and the client might have to leave.

Question 37

What regulatory differences are there between consumer and business buy to let mortgages?

Answer 37

Business buy to let mortgages are not regulated by the FCA.

Question 38

What is a consumer buy to let mortgage?

Answer 38

Consumer buy to let mortgages are defined as one ‘which is not entered into by the borrower wholly or predominantly for the purposes of a business carried on, or intend to be carried on, by the borrower.’

People who need consumer buy to let mortgages are often accidental landlords who need consumer protection.

Question 39

What is a business buy to let mortgage?

Answer 39

A mortgage which a person can take out for a property with the sole intention of renting it out as a way to increase their income.

Question 40

What is an unstructured loan?

Answer 40

Mortgages and loans on commercial property would fall under the title of unstructured loan.

It is possible to increase loan repayments, reducing the outstanding capital and, therefore, the interest.

Loans can usually be repaid at anytime.

Overdrafts and personal loans fall into this category.

Question 41

What is a structured loan?

Answer 41

Tend to be smaller purchases e.g. a sofa.

This type of loan will have a fixed rate of interest and a fixed repayment structure.

Since there is no collateral, and the risk is higher. Often, the costs are higher than an unstructured loan.