Repayment Methods Flashcards
Calculating Interest - Annual
- Interest is calculated on the balance outstanding at the beginning of the year
- With Capital Repayment no adjustment is made so each monthly payment is made on the same debt outstanding over 12 months
- More interest paid that with other methods
- No longer used much
- Benefit of repaying capital is not seen until the following year
Calculating Interest - Monthly
- Interest is calculated on a monthly basis
- Calculated on capital left each month
- More popular
- Monthly overpayments immediately impact the level of interest paid
- Pay much less interest over the term
Interest Annual Review Schemes
- Client pays the same each month
- Payment amount is set for the year
- This leads to overpayment of the mortgage
- Account is reviewed annually for new monthly payment amount based on the loan amount left and the appropriate level of interest
Calculating Interest - Daily
- For flexible mortgages
- As soon as a payment is made the interest is calculated on the outstanding balance
- Overpayments result in an immediate drop in interest
- Most beneficial for people overpaying their mortgage
Capital Repayment
- Loan is structured to pay capital & interest
- Guaranteed to pay off the loan
- Rates are higher than interest only
- As capital is paid off the interest lowers as it’s based on the capital amount left
- If interest rates go down during the term & the borrower maintains the same level of payment it can help to reduce the term
- Low risk
Interest Only
- No capital reduction
- Lower payments
- Capital required at the end of the term via a repayment vehicle
Payment calculated as:
£100k x 5% / 12 = £417pm
- High risk
Pure interest only
Doesn’t have a repayment vehicle or term, the loan is paid by the sale of the property
+ Only suitable for BTL
Retirement Interest Only Mortgage
Introduced in 2018 for borrowers over a certain age
- For borrowers with interest only mortgages before MMR that didn’t have a repayment vehicle or couldn’t repay the capital
- Open ended
- Repaid at death
- No repayment vehicle or roll up interest
Capital Repayment Vs Interest Only Payment
Interest only
£100k x 5% = £5k
Interest is £5k per year or £ £417 per month
Capital Repayment
£100k/1000 x 5.9127 (bank figure) = £591.27 per month or £7,095 per year
£5k still interest but £2,095 Capital is now paid
APRC
- Must show ARPC more prominently than the interest rate
- Not required if the actual rate isn’t shown
To calculate it is assumed
+ rates are to stay the same for 12 months
+ payments to be made on time
+ no insurance is added to the loan
+ the loan is not redeemed early
Costs included \+ total interest \+ arrangement fees \+ valuation costs \+ conveyancing \+ HLC if applicable \+ redemption fee on completion \+ home insurance if no alternative is offered
Does not include
- Early redemption fee
- Endowment/life assurance premiums or charges on default
ESIS Sheet
Shows warning for variable rate mortgage that rates may rise - shown as a 2nd APRC charge
- Second APRC rate must be shown
- If capped rate is reached straight away
- If uncapped APRC rate must be the highest in 20 yrs
- If tracker must show the highest rate in 20 years
Interest only repayment vehicles
Mortgage advisors can’t offer advice - only a level 4 advisor who is RDR compliant can
Options
+ Endowments
- full with profit & life cover
- Low cost with profit & life cover
- Unit-linked endowment & life cover
- Unitised with profit endowment & life cover
+ Collectives - no life cover, separate level term required
+ ISA - no life cover, separate life cover required
+ Pension Plan - no life cover, separate level term required
Qualifying/Non-Qualifying Rules (Life Cover)
Qualifying Life Assurance
- No further tax is paid other than 20% paid at source
- All UK companies offering whole of life policy & investment subject to 20% internal tax on profits
- Non tax payers 20% tax at source (non-refundable)
- Policy of a 10 year term or more
- Premiums paid for 10 years or 75% of the original term if less
- Premiums paid regularly, at least annually
- Sum assured on death is min of 75% of the premium payable
- Premiums paid in 1yr can’t exceed 2x premiums paid in another year
- Each person gets £3,600 PA paid per year, for joint policies it’ll be £7,200 PA
Non-qualifying means that more tax is paid if more than £3,600 is invested each year.
- HRT 20%
- ART 25%
Endowment with Profits
- Receive revisionary bonuses
+ insurer offers a smoothing effect normalising the dips and peaks
+ Simple bonus: declared as a percentage of original guaranteed sum assured
+ compound bonus: declared as a percentage of the original guaranteed sum assured plus the previous years bonus
Terminal bonus is added at death or maturity
- Client pays a monthly fee
- An annual management charge is taken from the fund
- Policy can be paid up but this reduces the GSA applied on maturity
+ Will still pay sum assured on death
Market Value Adjustment (MVA) - Life Assurance
Early surrender invokes a penalty if there are poor market conditions
Unit Linked Endowment
- Pays sum assured on death not maturity
- Can be extended or cashed in early
- Regular reviews - 10 years 15, 20 then every year
- Life cover is paid by cashing in units from the fund throughout the duration of the term
Charges
- Bid/offer- initial charge is 5%
- Annual management charge 0.5-1.5% annually
- Early surrender charge within the first 10 yrs with a reducing % until the end of the cancellation period
Endowment Shortfalls
Interest rates were high in the 90’s. As they dropped the value of the sum assured dropped and clients could no longer pay off their capital.
Now there is a traffic light system and regular reviews to avoid this for endowment linked mortgages
- in 1999 the FSA implemented new rules to reduce the risk of shortfall.
Policy providers must review endowments every 2 years and send letters to the policy holder in paper corresponding to traffic light classification
Red - High risk - Prompt action to be taken
Amber - Significant risk, consider action
Green - All is well
Endowment policyholders can complain to FOS if…
- The advisor recommended surrendering an existing endowment & taking a new one
- Mortgage loan is due before maturity
- The advisor didn’t explain the risks
- Policy holder retired before the endowment policy matured & the advisor didn’t check income affordability at retirement
Process
+ complain to the provider first then the FOS
+ complaint must be made within 6 years or 3 years from becoming aware (red letter) whichever is later.
Endowment shortfall solutions
- Switch shortfall to a capital repayment mortgage
- Repay early with a lump sum from a different source
- Convert mortgage to capital repayment & surrender endowment - new life cover will be required
- Savings elsewhere
- Extend endowment term (unit linked) and mortgage term
- Increase premiums, subject to qualifying rules
- Use compensation paid out from mis-selling
Collectives
- Unit Trusts
- Open Ended Investment Companies (OEIC)
Advantages
- Lump sum or periodically or both
- Get the skill of an experienced fund manager while spreading the costs across investors
- Reduces risk with fund diversification
- Manager can negotiate dealing costs due to the vast sums involved
Disadvantage
- Less control over where your money is invested
- Subject to capital gains & income tax
- Prices can go down as well as up
Unit Trusts
- Trust deed outlines the investment parameters
- Open ended (can sell more units to more investors)
- Each unit is a fraction of total assets
- Buy at offer price (higher as includes commission and admin fee) sell at Bid price
- Annual fund management charge 0.5-1.5% of fund value - this is deducted from the fund
- Valued at the same time each day
Forward Pricing
- If investor makes a purchase today the price of the unit want to be known until the revaluation point
For mortgage
- Advisor calculates how much is invested at projected growth rate to pay of the mortgage.
- Regular reviews are needed
Unit trust manager - fund manager
- Prices up units daily
- Sell & buy back units
- Mange investments in line with trust deed
Types of Unit Trusts
Accumulation Units (growth)
- Reinvested at growth
- Good for capital growth not income
- Income must be declared event though it isn’t received
Distributed Units (income)
- Income is distributed to unit holders
- Capital growth is lower
- Investor can still choose to reinvest
Unit Trust Approaches
Passive (tracker) Funds
- Not actively managed (lower fees)
Managed (active) Funds
- Actively managed
- Sticks to the parameters in the deed trust
Unit Trust Tax
Equity Trust - Dividends Paid Gross £2k Allowance - 7.5% BRT - 32.5% HRT - 38.1% ART
Fixed Income (non-equity) Unit Trust Income paid gross, can use interest allowance BRT - £1k HRT - £500 and usual bands for the rest
CGT only applies when moving or cashing in
Open Ended Investment Company (OEIC)
- Structured as a company
- Sell shares, not units
- Established under company law not the trust deed
Authorised Corporate Director (ACD)
- Fund manager
- No bid/offer spread
- Shares are single priced on a forward basis
- Initial charge is 3-6%
Cash ISA
- 16 years+
- Tax Free
- Not appropriate for mortgage
Stocks and Shares ISA
- 18 years+
- Income gains are tax free
- Risky as it’s based on stocks and shares, could go up or down
- Seen as suitable for a mortgage
Innovative Finance ISA
- Peer to peer lending
- Interest is tax free
- Unsuitable for mortgages as it’s very risky
ISA’s
- CGT free (losses can’t be offset)
- Annual investment cap of £20k
- ISA’s for single people not joint
- Withdrawals at anytime from stocks and shares, cash and innovative finance NOT H2B or Lifetime
Death with an ISA
- Can be transferred to a partner and stays tax free but the beneficiary cannot add additional funds.
- ISA remains invested until
+ Administration of the Estate
+ Closure of the account
+ 3rd anniversary of death
The transfer is called additional permitted subscription this will be for the value on death or at the point of transfer
Help to Buy ISA
Available since 2015
- Must have a National Insurance Number
- Joint savers have one each
Rules
- Max payments £1k upfront & £200 PM
- Max initial payment of £1,200
- When a property is found the government adds an additional 25%
- Scheme is available for 4 years
- Maximum bonus is £3k with £12k invested
- Minimum bonus is £400 with £1,600 invested
- Paid on completion directly to the solicitor
- Can’t contribute to a cash ISA in the same year
- House must be less than £450k in London
- House must be less than £250k outside London
Pension Mortgage
Client aims to use the 25% tax free lump sum at maturity
- Max input is £40k per year or the same as their salary if lower than £40k
- Non-taxpayer can invest £3,600 tax free
- Can make unlimited contributions, these are just tax free levels
- ART now lose £1 for every £2 they earn over £150k until it lowers to min of £10k
- Can carry forward an allowance for 3 years
- Any excess over lifetime allowance £1,073,000 at crystallisation is taxed at 55% if taken as a lump sum or 25% on excess if taken as income.
Pension Mortgage - Advantages
- Tax relief on contributions, 20% into the fund and a HRT & ART can claim extra relief via self-assessment.
- Tax free growth, no income or CGT within the fund
- Tax free lump sum up to 25%
- Wide selection of fund choice
- Flexibility on contributions going in
- Outside of the estate for bankruptcy and IHT
Pension Mortgage - Disadvantages
- Annual allowance is restricted to £40k
- Lifetime allowance is capped at £1,073,000
- Pension is not guaranteed to pay the capital in your mortgage.
- Can only be in a single name, cannot be in joint names
- Mortgage must cease over 55 yrs (57 in 2028)
+ might not be able to repay early - Separate life cover is required
- Pensions cannot be assigned to third parties
- Only 25% is tax free, might not be enough to cover the mortgage, anything withdrawn over the 25% is subject to 55% tax
- Cannot be put into trust
Lifetime ISA
- Since 2017
- 18-40yrs to fund up to 60yrs old
- Can invest £4k each year (cash or equities)
- Government gives 25% bonus each month up to £1k per year
- Withdrawal before 60 gets a penalty unless it’s for a property purchase
- Can be withdrawn after 60 tax free
Capital Repayment Vs Interest Only Payments
- Capital repayment payments are higher than interest only as they include Capital & Interest
