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CeMAP 1 - UKFR > Topic 13 > Flashcards

Topic 13 Flashcards

Secured and unsecured lending

1
Q

What is secured lending?

A

Secured lending is when a borrower provides an asset (e.g., property) as security for a loan. If repayments are not made, the lender can sell the asset to recover the debt.

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2
Q

What are some examples of assets that can be used for secured lending?

A

Property (e.g., homes), business premises, equipment, shares, and other financial assets.

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3
Q

What is unsecured lending?

A

Unsecured lending does not require an asset as security. The lender relies solely on the borrower’s agreement to repay, making it riskier, so interest rates are typically higher.

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4
Q

What is a repayment mortgage?

A

A mortgage where monthly repayments include both capital repayment (the original loan amount) and interest.

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5
Q

How does the proportion of capital and interest change over time in a repayment mortgage?

A

Early repayments mostly cover interest, while later repayments consist of more capital repayment.

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6
Q

What happens if a borrower dies before the mortgage is fully repaid?

A

Repayments must still be made or the loan must be repaid in full. Borrowers often take out life assurance to cover this risk.

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7
Q

What is the Loan-to-Value (LTV) ratio?

A

The loan amount expressed as a percentage of the property’s value. For example, a £80,000 loan on a £100,000 property gives an 80% LTV.

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8
Q

What is a Mortgage Indemnity Guarantee (MIG)?

A

An insurance policy that protects the lender if a borrower with a high LTV mortgage defaults and the property sale doesn’t cover the outstanding loan.

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9
Q

Who benefits from a MIG, and who pays for it?

A

The lender benefits, but the borrower pays the premium, either as a lump sum or added to the loan.

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10
Q

What is a mortgagor?

A

The borrower who takes out the mortgage and transfers the property to the lender for the loan’s duration.

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11
Q

What is a mortgagee?

A

The lender (e.g., bank, building society) that provides the mortgage loan.

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12
Q

What are covenants in a mortgage agreement?

A

Promises made by the borrower to:
Maintain the property in good condition.
Keep the property insured.

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13
Q

What rights does a lender have regarding insurance on a mortgaged property?

A

The lender can:
Insist on continuous property insurance.
Be noted as the mortgagee on the policy.
Use insurance proceeds to repair damage or reduce the mortgage debt.

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14
Q

What is an interest-only mortgage?

A

A mortgage where monthly payments only cover interest, meaning the capital (loan amount) remains outstanding and must be repaid in full at the end of the term.

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15
Q

Why are monthly payments lower on an interest-only mortgage compared to a repayment mortgage?

A

Because the borrower is only paying interest each month and not repaying any of the capital.

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16
Q

What requirement must be met before a lender can offer an interest-only mortgage?

A

The lender must obtain evidence of a credible repayment strategy to ensure the capital will be repaid at the end of the term.

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17
Q

What are examples of credible repayment strategies for an interest-only mortgage?

A

Cash or stocks and shares ISA
Pension
Investment bond
Shares or unit trusts
Regular savings plans

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18
Q

How often must lenders contact interest-only mortgage borrowers to check on their repayment strategy?

A

At least once during the mortgage term to ensure the strategy remains in place and sufficient to repay the capital.

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19
Q

What two key issues must borrowers address when taking out an interest-only mortgage?

A

Having a funding mechanism to repay the capital at the end of the term.

Ensuring there is sufficient protection (e.g., life insurance) in case they die before the loan is repaid.

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20
Q

What type of insurance is commonly used to protect an interest-only mortgage in case the borrower dies?

A

Level term assurance, which pays a lump sum to cover the mortgage if the borrower dies during the mortgage term.

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21
Q

What is a pension mortgage?

A

A mortgage repayment strategy where a borrower uses the lump sum from their personal or stakeholder pension to pay off the mortgage at retirement.

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22
Q

What percentage of a personal or stakeholder pension fund can be taken as a tax-free lump sum?

A

Up to 25%, known as the pension commencement lump sum (PCLS).

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23
Q

What is a personal pension?

A

A pension arranged on an individual basis, with benefits depending on the performance of invested funds, rather than being run by an employer.

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24
Q

What is a stakeholder pension?

A

A low-cost pension product that meets government standards on charges and contribution levels.

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25
What are two financial benefits of using a pension mortgage compared to an endowment policy?
Tax relief on contributions at the individual’s highest rate of tax. No tax on income or capital gains within the pension fund, allowing it to grow faster.
26
What is the lump sum allowance for tax-free PCLS in pension mortgages?
£268,275 unless a higher protected amount applies.
27
What is the minimum pension age for withdrawing benefits from a pension?
55 years old (increasing to 57 in 2028). This means the mortgage term must extend to at least this age.
28
What are the potential drawbacks of using a pension as a mortgage repayment vehicle?
Lump sum limit may not fully cover the mortgage. Minimum pension age may require a longer mortgage term. Not all providers allow taxable lump sums beyond 25% PCLS. Less retirement income, as funds are used for the mortgage. No built-in life assurance, requiring a separate policy. Cannot be assigned as security, unlike an endowment policy.
29
How is an ISA used as a mortgage repayment vehicle?
Regular investments are made into an ISA based on an assumed growth rate to accumulate a lump sum that repays the mortgage at the end of the term.
30
What are two benefits of using an ISA mortgage?
Funds grow free of tax on income and capital gains, reducing repayment costs. The mortgage may be repaid early if the ISA grows faster than expected.
31
What is the risk if an ISA does not perform as expected?
The final lump sum may be insufficient to repay the mortgage, requiring increased contributions.
32
Why is additional life assurance needed with an ISA mortgage?
The ISA value alone may be insufficient to repay the mortgage if the borrower dies during the term.
33
How do ISA contribution limits affect mortgage repayment?
Limits can make it difficult to save enough for large loans or short terms. Couples can combine their ISA allowances to build a larger fund.
34
What government schemes have supported ISAs for home purchases?
Help-to-Buy ISA (closed to new applications). Lifetime ISA, which helps save for a property deposit.
35
How do lenders apply interest to mortgages?
Interest may be charged annually, monthly, or daily, depending on the lender.
36
What is a variable rate mortgage?
A mortgage where monthly payments rise and fall in line with interest rate changes.
37
What is a discounted rate mortgage?
A mortgage where the interest rate is discounted from the lender’s standard variable rate (SVR) for a set period.
38
What is a fixed-rate mortgage?
A mortgage where the interest rate is fixed for a set period (e.g. 1–5 years) before reverting to SVR.
39
What is a capped rate mortgage?
A mortgage where the rate is variable but cannot exceed a specified upper limit.
40
What is a base-rate tracker mortgage?
A mortgage where the interest rate tracks the Bank of England’s base rate, with a slight margin added by the lender.
41
What is a flexible mortgage?
A mortgage that allows overpayments, underpayments, or payment holidays without penalties.
42
What is a low-start mortgage?
A repayment mortgage with lower initial payments, where capital is not repaid at first but payments increase later.
43
What is a deferred interest mortgage?
A mortgage where interest payments are postponed to later in the term, suiting borrowers expecting future income growth.
44
What is a CAT-standard mortgage?
A mortgage meeting government-set standards for Charges, Access, and Terms (CAT).
45
What is a green mortgage?
A mortgage offering better terms for energy-efficient homes, such as lower interest rates or cashback.
46
What is a cashback mortgage?
A mortgage where the lender gives the borrower a lump sum upon completion, often requiring repayment if the loan is repaid early.
47
How is interest calculated on a flexible mortgage?
Interest is calculated on a daily basis, reducing overall interest costs.
48
What is a key advantage of making overpayments on a flexible mortgage?
Overpayments reduce interest costs and shorten the mortgage term.
49
Under what conditions can a borrower underpay on a flexible mortgage?
They can underpay within lender-set limits, agreed upon at the outset.
50
What is a payment holiday in a flexible mortgage?
A temporary suspension of payments, allowed within lender-set parameters.
51
How does borrowing back overpayments work?
Borrowers can withdraw previous overpayments if they need funds later.
52
Do flexible mortgages typically have early repayment charges?
No, but they may have arrangement fees or require specific insurance.
53
Can borrowers access additional funds with a flexible mortgage?
Yes, they can draw down funds up to a pre-agreed borrowing limit.
54
How do flexible mortgages simplify additional borrowing?
They have easier administrative processes compared to standard further advances.
55
What happens if a borrower takes additional funds under a flexible mortgage?
The additional borrowing takes priority over any new charges on the property.
56
What is a current account mortgage?
A mortgage combined with a current account, where salary credits and daily interest calculation help reduce mortgage costs.
57
How does a current account mortgage reduce interest costs?
Salary credits lower the mortgage balance before interest is calculated daily.
58
What is an offset mortgage?
A mortgage where savings are offset against the mortgage balance to reduce interest charges.
59
How does an offset mortgage work in practice?
If a borrower has an £80,000 mortgage and £25,000 in savings, interest is charged on £55,000 instead of £80,000.
60
How often is the offset mortgage calculation updated?
The offset calculation is updated daily.
61
What is the purpose of shared-ownership schemes?
To help low-income individuals become homeowners by purchasing a share of a property while renting the remainder.
62
How do shared-ownership schemes work?
Borrowers buy a percentage of the property (e.g., 25%) with a mortgage and pay rent on the rest, with the option to buy further shares later.
63
What is staircasing in shared ownership?
The process of gradually increasing ownership of the property by buying additional shares over time.
64
Do all lenders offer mortgages for shared ownership?
No, not all lenders provide mortgages for shared-ownership properties.
65
What is equity in a mortgage context?
The difference between a property’s market value and any outstanding loans secured against it.
66
Who is equity release designed for?
Older homeowners (typically 55+) with limited pension income who want to access capital from their home.
67
What must a homeowner do if they have a small mortgage but want equity release?
They must pay off their existing mortgage as part of the arrangement.
68
What is the role of the Equity Release Council?
It ensures equity release products are safe and that providers follow industry standards and consumer protection rules.
69
How much can a borrower typically get with a lifetime mortgage?
Up to 55% of the property’s value, depending on age.
70
What is the typical interest structure for a lifetime mortgage?
Interest is usually fixed-rate and is rolled up rather than paid regularly.
71
When is a lifetime mortgage repaid?
When the borrower dies or moves into long-term care, the property is sold to repay the loan.
72
What is the no-negative-equity guarantee?
Borrowers will never owe more than their property's value when the loan is due.
73
How does a drawdown lifetime mortgage differ from a standard one?
It allows borrowers to withdraw funds in stages, so interest accrues only on the amount actually borrowed.
74
How does a home reversion plan work?
The homeowner sells a portion or all of their home to a provider while retaining the right to live there rent-free or at a reduced rent.
75
When does the home reversion provider receive their share of the property?
When the borrower dies or moves into long-term care, the property is sold, and the provider receives their agreed share of the proceeds.
76
Which regulatory body oversees equity release schemes?
The Financial Conduct Authority (FCA) under the Mortgages and Home Finance: Conduct of Business (MCOB) rules.
77
Who can advise on or arrange equity release products?
Only individuals with specialist qualifications as required by the FCA’s Training and Competence sourcebook.
78
How does a retirement interest-only mortgage differ from equity release?
Borrowers must repay interest monthly rather than rolling it up.
79
How is a retirement interest-only mortgage repaid?
When the borrower dies or moves into long-term care, the property is sold to repay the loan.
80
What must a borrower prove to get a retirement interest-only mortgage?
That they have sufficient income to afford the monthly interest payments.
81
What is a secured loan?
A loan where the borrower offers an asset as security, allowing the lender to sell the asset if the borrower defaults.
82
What is the most common type of secured personal lending?
A mortgage loan, where the lender takes a first charge on the borrower’s property.
83
Why might homeowners borrow against increased equity in their property?
To fund non-house-related purchases or to improve their lifestyle.
84
What are three ways a borrower can access equity from their home?
A further advance from their existing lender. A second mortgage from a different lender. Remortgaging for a larger amount.
85
What is bridging finance used for?
To bridge the funding gap when buying a new home before selling an existing one.
86
What is a second mortgage?
A loan secured against a property that already has a mortgage, with the new lender taking a second charge.
87
What happens in the event of a default on a second mortgage?
The first charge lender is repaid first, and the second mortgage lender is only repaid if there are remaining funds.
88
Why do second mortgages have higher interest rates than first mortgages?
They represent a higher risk to lenders since the first mortgage lender is repaid first.
89
Since when have second charge mortgages been regulated by the FCA under MCOB?
Since 21 March 2016.
90
When might a borrower require bridging finance?
When they need to complete a house purchase but have not yet sold their existing property.
91
How is bridging finance repaid?
Once the borrower sells their original property or secures a mortgage on the new home.
92
What are the two types of bridging finance?
Closed bridging – The borrower has a firm buyer for their existing home and a clear repayment plan. Open bridging – The borrower does not yet have a buyer for their current home.
93
Which type of bridging finance carries a higher risk and interest rate?
Open bridging finance, because the borrower does not have a guaranteed buyer for their property.
94
What is commercial lending?
Commercial lending refers to loans to businesses, from sole traders to multinational companies, for purposes like starting or expanding businesses, purchasing property, or refurbishing premises.
95
How are commercial loans typically secured?
They are secured on the company’s property or other assets.
96
What factors affect the interest rate on a commercial loan?
The interest rate depends on risk assessments based on factors such as the company's past performance, business plans, projected profits, management quality, and the business sector.
97
What is the main difference between secured and unsecured loans?
In unsecured loans, the borrower's personal promise (or covenant) is relied on for repayment, rather than an asset securing the loan.
98
Why are unsecured loans higher risk than secured loans?
Because there is no asset backing the loan, which makes the lender’s recovery options more limited if the borrower defaults.
99
What is a personal loan?
A personal loan is a fixed-term loan offered by banks, building societies, and finance houses, typically for 1-5 years, with a fixed interest rate.
100
What is credit scoring in personal loan applications?
Credit scoring is a method used by lenders to assess a borrower’s suitability for a loan based on their credit history.
101
Can personal loans be used for any purpose?
Yes, they can be used for any legal purpose, such as buying a car, going on holiday, or consolidating debt.
102
What is an overdraft?
An overdraft is a current account facility allowing the customer to spend more than they have in their account, up to a set limit, to manage short-term financial gaps.
103
What is the difference between an arranged and unarranged overdraft?
Arranged overdraft – Agreed in advance with the bank and comes with a set limit. Unarranged overdraft – Occurs when the overdraft limit is exceeded or not previously agreed.
104
What change happened in April 2020 regarding overdraft charges?
Banks and building societies are now only allowed to charge a single annual interest rate on overdrafts.
105
How do credit cards work?
Credit cards provide a revolving credit facility, allowing customers to borrow up to a limit and repay at least a minimum amount monthly, with interest charged on the balance if not paid in full.
106
What is a revolving credit facility?
A system where the customer can borrow more as they repay existing debt, giving them continuous access to credit.
107
What happens if the full credit card balance is paid within the grace period?
No interest is charged if the full balance is repaid within a typical grace period (usually 25 days).
108
Why are credit cards considered an expensive form of borrowing?
They often have higher interest rates compared to other lending products and may charge fees for cash advances or overseas transactions.
109
How do credit card companies earn from retailers?
They charge retailers a percentage fee (usually around 3%) of the transaction value when customers use credit cards for purchases.

CeMAP 1 - UKFR (25 decks)

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