Pt 2. Serving the Retail Consumer - Mortgages and Loans

Question 1

What is a mortgage?

Answer 1

A mortgage is the security offered in exchange for the loan.

Question 2

What is an assignment?

Answer 2

An assignment is the transfer of ownership, when the security is signed over to the lender in exchange for the mortgage.

• Usually on a property loan, it is the deeds of the property, but few now take actual deeds due to cost and risk of storage.
• Many now register charge on property with Land Registry.

Question 3

What are the 2 main ways in which a mortgage can be repaid?

Answer 3

1. Capital and interest repayment
2. Interest-only

Question 4

What is capital and interest repayment?

Answer 4

• Where monthly repayments to lender include a sum to cover a contribution towards repayment of capital, plus sum to cover interest.
• The loan is gradually repaid during mortgage term, and interest payable reduces in line with reducing outstanding capital.
• This means lenders keep monthly costs the same overall, but with interest element falling over time, and capital with increase.
• Monthl repayments usually change if interest rates change, and client does not have a fixed rate deal.

Question 5

What is an interest only mortgage?

Answer 5

• When the interest accruing on loan is paid and outstanding capital remains the same.
• This has an objective to repay from another source at end of term (e.g. via endowment policy, ISA, tax free cash from pension or other savings and investments) or by selling the property.

Question 6

What is the Mortgage Market Review (MMR)?

Answer 6

This came into effect in April 2014, significantly reducing the availability of interest-only mortgage, with lenders now required to check borrowers wishing to take out interest-only mortgage have a credible repayment strategy.

Question 7

What is a capped mortgage?

Answer 7

This is when a lender guarantees interest rate will not rise above a given level for a certain period of the loan.

Question 8

What is a cap and collar mortgage?

Answer 8

When interest rate on loan will not rise above given level, and also a minimum rate below which interest will not fall.

Question 9

What is a discount mortgage?

Answer 9

The interest rate charged for an initial period of loan (1,2,3 years) reduced by set percentage below standard rate charged by lender.

Question 10

What is a euro mortgage?

Answer 10

When interest and capital of loan is deisgnated in euros, to take an advantage of lower interest rates, resulting in gains or losses as currency ER moves relative to sterling, but useful for indidvuals paid in overseas currency.

Question 11

What is an equity linked mortgage (or shared appreciation mortgage (SAMs))?

Answer 11

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

On property sale, the proportion of lenders equity stake is repaid to them and possible for borrower to slowly accrue lenders equity stake overtime.

Question 12

What is a fixed interest mortgage?

Answer 12

When interest rate charge remains fixed for given period, and borrowers takes risk IR generally may fall beow rate charged, in exchange have known liability for mortgage interest over fixed period.

They often carry early redemption penalities.

Question 13

What is a flexible mortgage?

Answer 13

When monthly payments can be varied if required and lump sum capital repayments made at any time.

If capital is repaid, it creates a reserve which borrower can withdraw cash up to initial mortgage amount at any time.

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

Question 14

What is a green mortgage?

Answer 14

This is one that rewards borrower for buying an energy efficient home offering them more favourable terms than come as standard, such as lowering interest rate or cash back when take out mortgage, or both.

Such deals may be restricted to new builds.

Question 15

What is an offset mortgage?

Answer 15

This is when mortgage account and current account are linked, interest is charged on net balance of 2 accounts, so if money is kept in current, the size of mortgage is effectively reduced.

The effect of monthly salary going in can have an effect, and reduce overall interest payments.

Question 16

What is a tracker mortgage?

Answer 16

When variable rate mortgage has an automatic link built in, so interest tracks an index, usually BofE base rate.

This is designed to move as index moves usually after a period of 15 days.

Question 17

What is an equity release?

Answer 17

This is a range of products only available to older clients, typically over 60, to release cash tied up in their home

• No fixed term
• Allowed to stay home for the rest of their life, or until they move to long-term care facility.
• Can be expensive and inflexible if clients circumstances changes in the future.
• May affect current or future entitlement to State and local authority benefits.

Question 18

Name some equity release schemes:

Answer 18

1. Lifetime mortgages
2. Home reversion plans

Question 19

What is a lifetime mortgage?

Answer 19

This means the client takes out a loan secured on the home.

Question 20

Types of lifetime mortgages:

Answer 20

1. Roll-up mortgage - lump sum or regular income charged a monthly or yearly interest added to the loan. (Original amount borrowed + rolled-up interest repaid when home is sold.)
2. Fixed repayment - client gets lump sum, but not charged in interest, so when home is sold the lender is paid a higher amount than borrowed, agreed in advance.
3. Interest only - client gets lump sum, pays monthly interest on loan (fixed or variable), with original amount borrowed repaid when home is sold.
4. Home income plan - the money borrowed used to buy regular fixed income for life (annuity), with income used to pay interest on mortgage and rest of clients, with original amount borrowed repaid when home is sold.

Question 21

What is a drawdown facility?

Answer 21

This is suitable if clients want to take occasional small amounts rather one big loan, often cheaper as clients only pay interest on the money they actually need.

Question 22

What is a no negative equity guarantee?

Answer 22

This is a lenders promise that the client (or beneficiaries) will never have to pay back more than the value of the home, even if the debt has become larger than this.

Question 23

What is a home reversion plan?

Answer 23

When client sells all or part of their home in return for a cash lump sum/regular income or both, with it belonging partially to the home reversion provider, but client is allowed to live in it until they die or in care.

• Clients usually getr 20-60% of market value of home. (older = higher %)
• Clients may be asked to pay monthly nominal rent, or higher rent for more money from sale.

Question 24

2 types of Sharia-compliant home purchase plans available:

Answer 24

1. Ijara - monthly payments made towards buying the property are held by firm and used to buy home at end of agreement.
2. Diminishing musharaka - payment made to buy property buys extra slice of firms share, as clients share increases, firms get smaller, and so does rent paid for use of firms share.

Question 25

What is a flash sale/mortgage rescue/rent back or sell-to-let scheme?

Answer 25

When companies offer to help clients with financial difficulties by buying them their home and renting it back to them for a fixed period, to buy a home back quickly within a week or often 3-4 weeks.

Question 26

What to be aware of with sale and rent back agreements?

Answer 26

• Clients are paid less than full makret value of home.
• Clients should check how long they can stay in their home, as rental agreement may not be renwed, so could leave after initial term end.
• Clients can still be evicted if they breach terms of tenancy.
• If firm buying home gets into financial difficulties, the property may be repossessed and may have to leave.

Question 27

Which mortgage is not regulated by the FCA?

Answer 27

Business buy to let mortgage.

Question 28

What is a consumer buy to let mortgage?

Answer 28

This mortgage covers lending to some consumers and are regulated by the FCA.

Defined as one ‘which is not entered into by the borrower wholly or predominantly for the purposes of a business carried on, or intended to be carried on by the borrower.

e.g. borrowers travelling overseas who need to let out home to cover mortgage, borrowers inheriting a mortgaged property who need to let it out, borrowers moving elsewhere who do not wish to sell existing property.

Borrowers are seen as accidnetal landlords, in need of consumer protection.

Question 29

Business buy to let mortgage

Answer 29

e.g.

• Borrower uses mortgage to buy a property intending to rent it out.
• Borrower already owns another property.
• Borrowers nor relatives live in this property.

The above characterises a business than consumer activity so suhc borrowers do not need to be protected by FCA.

Question 30

Name two types of loans:

Answer 30

1. Unstructured Loan
2. Structured Loan

Question 31

What is an unstructured loan?

Answer 31

e.g. mortgages and loans on commerical property.

With this, it is possible to increase loan repayments, reduce capital outstanding, hence interest.

Loans can be repaid at any time (without penality) to save more interest - including some overdrafts and personal loans.

Interest rate varies depending on risk of default, usually related to base rate:

1% above base = good
4% above base = lenders feels there is a higher than average risk of default.

Question 32

What is a structured loan?

Answer 32

For smaller purchases, such as a sofa or car.

Usually a fixed rate of interest payable over term of loan, and fixed repayment structure.

Structured nature means payments do not chnage if base rates alter, making budgeting easier.

Con: Loan falls at a higher risk end of the market, often where there is no collateral to back up loan - with costs being higher than an unstructured loan.

Question 33

When can a penalty for a loan occur?

Answer 33

For structured lending, if loan is repaid before end date there is usually a penalty, with lenders making a fixed profit on loans, ensuring same profit even if loan is repaid early.