Topic 13: Secured and Unsecured Lending

Question 1

What is a Mortgagee?

Answer 1

The lender of a mortgage.

Question 2

What is a Mortgagor?

Answer 2

The mortgage borrower

Question 3

What is an Offset Mortgage?

Answer 3

A mortgage where the borrower’s savings are held in the mortgage account or a linked account. No interest is paid on the savings, but the amount of savings is ‘offset’ against the mortgage amount, and interest is only paid on the net amount. Eg – mortgage £100,000, linked savings £20,000 – mortgage interest charged on £80,000.

Question 4

What is a Mortgage Indemnity Guarantee?

Answer 4

A form of insurance policy to protect a lender from a high loan to value mortgage borrower defaulting. The sum assured is the difference between what the lender would normally have lent and the increased mortgage. If the borrower defaults and the lender has to take possession and sell the property, the policy will pay out on any loss above the normal mortgage amount. Protects the lender only – the insurer can chase the borrower for the amount paid out.

Question 5

What is Shared Ownership?

Answer 5

The buyer buys a share (usually 25–50%) in the property from a provider (usually a housing association), and pays rent on the part not bought. The buyer can buy further ‘chunks’ later – known as staircasing.

Question 6

What is Home Reversion?

Answer 6

Available to older homeowners. A reversion provider buys all or part of the property for a lump sum and allows the owner to remain in the property on a lease with a nominal rent (up to £12 a year), until their death or move into care. The property is then sold and the reversion company keeps the proceeds from the part it owns – 100% if it owns all the property.

Question 7

What is Second Charge/ Second Mortgage?

Answer 7

A loan secured on a property with a legal charge, but second priority after the first mortgage for repayment. On sale, death or default, the first mortgage must be repaid fully before the second charge is repaid – may not be enough for repayment.

Question 8

What are the two basic types of mortgage?

Answer 8

• a repayment mortgage, sometimes known as a capital‑and‑interest
  mortgage;
• an interest‑only mortgage.

Question 9

What is secured lending?

Answer 9

Lending is ‘secured’ when the borrower gives the lender the right to take
possession of a specific asset if they (ie the borrower) fail to keep up repayments on a loan. In the event that repayments are missed and the matter cannot
be resolved in any other way, the lender can then sell the asset to recoup
the money it is owed. Figure 13.1 outlines the process in relation to lending secured on a home

Question 10

What is Unsecured Lending?

Answer 10

With unsecured borrowing, the lender does not have the reassurance of an
asset that they can sell to recoup the loan if the borrower fails to repay it.
The lender has to rely on the borrower’s agreement to repay. For this reason, unsecured borrowing represents a greater risk to the lender, and thus interest rates on unsecured loans tend to be higher than those for secured loans.

Question 11

What is Loan To Value (LTA) Ratio?

Answer 11

The amount of the loan in relation to the value of the asset used for
security, expressed as a percentage. For a mortgage loan of £80,000 on a property valued at £100,000, the LTV is 80 per cent.

Question 12

What is a Repayment Mortgage?

Answer 12

With a repayment mortgage, the borrower makes monthly repayments to the
lender. Each monthly amount consists partly of capital repayment (ie the
original amount borrowed) and partly of interest on the amount borrowed. The higher the interest rate (for any given mortgage amount and term), the higher the monthly repayment.

Question 13

What is an Interest Only Mortgage?

Answer 13

With an interest‑only mortgage, the monthly payments made to the lender are solely to pay interest on the loan. The capital amount outstanding therefore
does not reduce at all. For this reason, the monthly payments are lower than those for a repayment mortgage. However, the borrower still has to repay the
original amount borrowed at the end of the term. An interest‑only mortgage can now only be arranged if the lender has obtained evidence that the borrower has a credible repayment strategy in place.

Question 14

What is a Pension Mortgage?

Answer 14

One of the benefits of a personal pension plan or stakeholder pension is that up to 25 per cent of the accumulated fund can be taken as a tax‑free pension commencement lump sum (PCLS). Depending on the rules of the pension provider, it may also be possible for holders of a personal or stakeholder pension plan to draw an additional amount, over and above the 25 per cent PCLS, as a taxable sum. The availability of a lump sum from normal minimum pension age means that these pension plans have the potential to be used as
mortgage repayment vehicles.

Question 15

What are Individual Savings Account Mortgages?

Answer 15

In order to use an ISA as a mortgage repayment vehicle, ISA managers calculate the amount of regular investment that would be required to produce the necessary lump sum at the end of the mortgage term, based on an assumed
growth rate and on specified levels of costs and charges. All managers allow investments to be made on a regular monthly basis, provided, of course, that the overall annual limits are not exceeded.

Question 16

What is Equity Release?

Answer 16

In a mortgage context, ‘equity’ is the excess of the market value of a property over the outstanding amount of any loan or loans secured against it. Equity
release plans are designed to enable older homeowners with limited pension income who typically do not have a mortgage on their property to release
some of the equity in order to provide capital or supplement their income. A homeowner with a small mortgage may also be eligible; the existing mortgage would have to be paid off as part of the arrangement. Most of the schemes
are available only to property owners over the age of 60, and many have a minimum age of 70.

Question 16

What are Flexible Mortgages?

Answer 16

The flexible mortgage gives the borrower some scope to alter their monthly payments to suit their ability to pay, as well as the opportunity to pay off the loan more quickly. Although there is no precise definition of a flexible mortgage, it is generally considered that such a product should offer the following basic features:
- interest calculated on a daily basis;
- the facility to make overpayments at any time without incurring an early repayment charge;
- the facility to underpay, but only within certain parameters set out by the lender when the mortgage was arranged;
- the facility to take a payment holiday, again within certain parameters laid
down at the outset.

Question 17

How does a lifetime mortgage work?

Answer 17

For a lifetime mortgage, a lender will usually be prepared to lend up to a
maximum of 55 per cent of the property value, depending on the borrower’s age. The majority of lifetime mortgages are on a fixed‑rate basis and take into account the fact that, unlike with a standard mortgage product, the term of the loan is unknown.

Interest is charged at the lender’s lifetime mortgage rate, but generally no regular payments of capital or interest are made. Instead, the interest is added to the loan (rolled up). When the borrower dies or moves into long‑term care, the property is sold and the mortgage loan plus rolled‑up interest is repaid to the lender. If any of the sale proceeds remain once the loan has been repaid, the borrower, or their estate, receives the balance. If the property is owned
jointly, the mortgage continues until the second death or vacation of the property.

Question 18

How does a home reversion plan work?

Answer 18

Home reversion plans involve the homeowner selling a percentage or all of their property to the scheme provider. The customer(s) retains the right to live in the house, rent‑free (or for a nominal or partial rent), until their death(s) or
until they move into permanent residential care. At that point the property is sold and the provider receives a share of the proceeds equivalent to their
share of ownership. Thus if they owned 40 per cent of the property, they would receive 40 per cent of the sale proceeds.

Question 19

How are equity release schemes regulated?

Answer 19

Equity release schemes, defined as lifetime mortgages and home reversion plans, are regulated by the FCA under the Mortgages and Home Finance:
Conduct of Business (MCOB) rules. MCOB 8 and 9 are the sections of MCOB specifically directed at equity release and lifetime mortgages, although the general MCOB rules regarding suitability and affordability also apply.

Question 20

What are retirement interest only mortgages?

Answer 20

Retirement interest‑only mortgages are similar to equity release schemes
insofar as the outstanding debt is repaid from the proceeds of the sale of the
property when the borrower dies or moves into long‑term care.The main difference is that the borrower must repay the interest during the
term of the mortgage and must be able to prove to the lender that they can afford to do so.

Question 21

What is Bridging Finance?

Answer 21

Bridging finance may be required when a borrower wishes to move house but has not managed to sell their existing property, or the funds from the sale
will not be available at the time completion of the new purchase is due. It is short‑term lending that is repaid when the original property is sold and the owner is able to secure a mortgage on their new home.

Question 22

What are the two types of bridging finance?

Answer 22

There are two types of bridging finance:
- Closed bridging – the borrower has a feasible plan for repaying the loan within an agreed timescale. Typically, this is through the sale of the existing property and requires the borrower to have a firm buyer.
- Open bridging – the borrower needs finance to buy the new property, but does not yet have a firm buyer for their existing property.Open bridging represents a higher risk to the lender than closed bridging. Interest rates for open bridging are therefore higher than those for closed bridging

Question 23

What is Unsecured borrowing?

Answer 23

In contrast to secured loans, an unsecured loan relies on the personal promise, or covenant, of the borrower to repay. Unsecured loans are, therefore, generally
higher risk than secured lending, with the consequence that they are subject to higher rates of interest and are normally available only for much shorter
terms. For example, while a mortgage secured on a property will be available
for 25 years or even longer, a personal loan is rarely offered over much more than six or seven years.

Question 24

What are Personal Loans?

Answer 24

Personal loans are offered by banks, building societies and some finance houses. They are normally for a term of one to five years; the interest rate is generally fixed at the outset and remains unchanged throughout the term. Many of the larger lenders assess loan applications on a centralised basis,
using a form of credit scoring to assess the suitability of the borrower.

A customer can use a personal loan for any (legal) purpose: typically, it might be used to purchase a car, fund a holiday, or consolidate existing higher‑cost
borrowing such as a credit card balance

Question 25

What are Overdrafts?

Answer 25

An overdraft is a current account facility that enables the customer to continue to use the account in the normal way, even though its funds have been
exhausted (although the provider does set a limit on the amount by which the account may be overdrawn). It is a convenient form of short‑term temporary
borrowing, with interest calculated on a daily basis, and its purpose is to assist the customer over a period in which expenditure exceeds income – for instance, to pay for a holiday or to fund the purchase of Christmas gifts.

Question 26

What are Credit Cards?

Answer 26

Credit cards enable customers to shop without using cash or debit cards in any establishment that is a member of the credit card company’s scheme.
Most retailers have terminals linked directly to the credit card companies’
computers, enabling online credit limit checking and authorisation of
transactions.

As well as providing cash‑free purchasing convenience, credit cards are a source of revolving credit. The customer has a credit limit and can use the card for purchases or other transactions up to that amount, providing that at least a specified minimum amount (usually 3 per cent of the outstanding balance)
is repaid each month. The customer receives a monthly statement, detailing recent transactions and showing the outstanding balance. If the balance is
repaid in full within a certain period (usually 25 days or so), no interest is
charged; if a smaller amount is paid, the remainder is carried forward and interest is charged at the company’s current rate.

Credit cards are an expensive way to borrow, with rates of interest considerably higher than most other lending products. There is also normally a charge if
the card is used to obtain cash either over the counter or from an ATM, or if the card is used overseas.

Credit card companies charge a fee to retailers for their service. This is
deducted as a percentage (typically
around 3 per cent) of the value of transactions when the credit card
company makes settlement to the
retailer.

Question 27

What is Revolving Credit?

Answer 27

An arrangement whereby the customer can continue to
borrow further amounts while repaying existing debt.