Topic 24 - Other mortgage products (unit 6)

Question 1

What is a foreign currency mortgage?

Give examples of this type of mortgage

Answer 1

A foreign currency mortgage is one where the borrower’s income is in a different currency from that applying to the mortgage.

Example 1: An individual has a UK property with a sterling mortgage, but it is paid in euros

Example 2: A Spanish mortgage used to fund a UK resident’s holiday home in Spain

Question 2

Tell me about why foreign currency mortgages are typically only possible to high net worth customers

Also tell me why foreign currency mortgages secured on UK property gained massive popularity and why this popularity has now fallen

Answer 2

Foreign currency mortgages include a combination of high minimum loans, low loan‑to‑value limits,
set‑up costs and high risks. This means they are only of interest to high‑net‑worth individuals with very large mortgages

The reason they gained massive popularity in the UK is because UKs interest rates were very high compared to other countries like Japan or Switzerland. The interest rate payable is determined by the rates applicable to the currency in the country in which it is used (eg if the currency is the yen, Japanese interest rates apply). Mortgagors therefore took out the mortgage in one of those low interest countries in aim to reduce borrowing costs. The reason this popularity didn’t last is because rates in the UK fell and aligned with other countries so the risk of currency fluctuations was no longer worth taking.

Question 3

Tell me the key points relating to foreign currency mortgages

Answer 3

The mortgage is arranged in a foreign currency and secured on a UK property.

The capital owed is denoted in that currency.

Each repayment is made in that currency – which means converting from sterling.

The interest rate is determined by the rates applicable to that currency in the country in which it is used (eg if the currency is the yen, Japanese interest rates apply).

There is usually a very high minimum loan – at least £250,000 in most cases.

Loans are usually available on a repayment or interest‑only basis

Question 4

For understanding. Here is an example of a foreign currency mortgage

Question 5

What are ‘credit impaired’ borrowers?

Answer 5

It is how the FCA refers to those who have suffered credit problems in the past

Question 6

What do the FCA call those who have suffered credit problems in the past

Answer 6

‘Credit Impaired’

Question 7

What is a guarantor mortgage?

Tell me about it

Answer 7

A specific product designed for first time buyers

The applicants are responsible for the debt in the first instance, but if they fail to meet the interest or capital payments as required, the guarantor becomes responsible for some or all of the debt, depending on whether the guarantee is on a full or limited liability basis

The product will allow higher lending than a standard mortgage.

Question 8

An issue with guarantor mortgages is that the guarantor faces lots of risk

For many people this risk is too great

For this reason what do some lenders offer instead of guarantor mortgages?

Answer 8

‘Surety’

Where a third party’s savings are assigned to guarantee a loan

How it works: Family members provide security by placing cash equal to a set percentage of the purchase price (typically 10%) in a savings account with, and assigned to, the lender.

The borrower then arranges the repayment mortgage

The savings account is locked to the lender for a minimum period and earns interest.

If the mortgage account is conducted satisfactorily, the savings are released after an agreed period, the guarantee is cancelled and the mortgage continues as normal.

If, however, there are problems with the mortgage account during the agreed period, the lender uses the savings as security to make up any deficit.

NOTE: By the end of the lock‑in period, the borrower will have repaid enough of the mortgage to bring the loan closer to (or within) the lender’s normal limits, and the lending risk will have reduced to acceptable levels

Question 9

There are two types of Islamic home finance

What are they?

Answer 9

Ijara – which follows the acceptable principle of leasing;

Murabaha – which follows the acceptable principle of co‑ownership

Question 10

What is Islamic home finance?

Answer 10

Islamic home finance is based on Islamic finance principles and has been developed to allow Muslims
to raise the finance to buy property without compromising religious principles (ie no interest)

Question 11

Tell me about the Ijara method of Islamic Home finance

Answer 11

Customer selects property

Bank buys property and retains ownership (customers ‘makes legal promise’ to buy property)

Customer occupies property under a lease of up to 25 years

Customer makes monthly payment to bank comprising capital repayment and rent. Payments reviewed every 12 months and rent adjusted to reflect
general changes in interest rates ( rent is how the bank makes its profit)

Property transferred to customer’s ownership at end of lease term. (EARLY REPAYMENT IS POSSIBLE)

NOTE: In comparison with a conventional mortgage, the Ijara method is more expensive – the monthly payments tend to be higher

Question 12

Tell me about the Murabaha method of Islamic Home finance

Answer 12

Customer selects property

Bank buys property

Bank immediately sells property to customer at higher price than the bank paid making the customer legal owner of the property. (NOTE: Sale price depends on repayment term – can be up to 15 years)

Customer makes initial payment (eg 20% of purchase price)

Customer continues to make fixed monthly capital payments for rest of repayment term

NOTE: The Murabaha arrangement is less popular than the Ijara approach as it is more expensive overall and less flexible in terms of early repayment. Also, properties purchased under ‘Right‑to‑Buy’ schemes cannot qualify

Question 13

Tell me about self build mortgages

Answer 13

Self‑build mortgage allows the borrower to purchase the land and finance the construction as well, with funds released at key completion stages of the
build process,

For example, lenders will release the initial funding on purchase of the land. They will then release more funding on completing of the roof and then more funding on completion of plastering and so on. Before releasing any funds the lender will inspect the work to confirm it has been completed satisfactorily

Some lenders consider advancing funds at the start of each significant phase, known as advance stage payments, before any work is complete. This is more risky to the lender so higher rates are charged

Question 14

What are buy to let mortgages?

Answer 14

A buy‑to‑let mortgage is designed to enable an individual to finance a property for letting rather than for owner occupation

There are two types. The majority being business BTL and the a small percentage being Consumer BTL

Business BTL mortgages are not regulated by the FCA and are outside the scope of MCOB

CONSUMER BTL MORTGAGES ARE REGULATED BY THE FCA AND ARE UNDER THE REMIT OF MCOB

Question 15

What are consumer buy to let mortgages?

Answer 15

A CBTL mortgage contract is 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’ (Mortgage Credit Directive Order, 2015).

Borrowers are described as ‘accidental landlords’
because they are people who need to let out a property because of personal circumstances, rather than because they have made a conscious choice to buy a property for rental. Such circumstances might include those who inherit a property or people who need to move quickly because they have a new job
and do not have time to sell their family home before moving

Question 16

Tell me about business BTL mortgages

Answer 16

For those looking to use property as an
investment

Question 17

Tell me disadvantages of Business BTL mortgages for the borrower

Answer 17

Lenders usually limit BTL lending to 75–80% of the property valuation, and set a minimum property value.

Lenders usually require the BTL borrower owns their
main residence in full

Most lenders require a minimum gross income, typically £20,000–25,000 for single applicants

Most lenders set a minimum and maximum age range
typically between 18 and 25 years old as a minimum, with the mortgage typically ending by age 75.

The borrower must usually be employed, self‑employed or retired with a pension

The PRA requires a rental cover ratio of at least 125%, although lenders usually set much higher. For example, if the net rent is £800 a month, the maximum mortgage payment will be £640 (800 ÷ 125%) and the maximum mortgage will be whatever that level of repayment would provide

Question 18

For business BTL mortgages, the PRA sets a rent

Question 19

If a buy‑to‑let mortgage is not regulated under the FCA’s MCOB regime or the Mortgage Credit Directive Order 2015, who is it regulated by?

Answer 19

The lender and its lending activities are
regulated by the PRA

Question 20

Who are BTL mortgages regulated by?

Answer 20

Depends on the type of BTL mortgage.

Consumer BTL mortgage = FCA under MCOB
Business BTL mortgage = PRA

Question 21

The PRA issued a supervisory statement in September 2016, entitled Underwriting standards for buy‑to‑let mortgage contracts

What was this statement regarding?

Answer 21

The PRA issued this response to concerns about issues with the affordability of buy‑to‑let mortgages that were NOT regulated under the FCA’s consumer buy‑to‑let regime

The statement outlines minimum expectations for
the standards firms must apply when underwriting non‑FCA regulated buy‑to‑let mortgages (Ie, BTL mortgages for business or investment purposes )

Question 22

How does the PRA define BTL mortgages?

Answer 22

The PRA defines a buy‑to‑let mortgage as the following:

A mortgage secured on land in the UK in pounds sterling

A Minimum 40% of the land is used or will be used in connection with a dwelling

The land subject to the mortgage will not ever be occupied as a dwelling by the borrower or by a related person (ie family member like spouse)

The tenant must occupy the land on the basis of a rental agreement. For it to class as a rental agreement it must be for longer than 1 month

NOTE: The PRA state that an agreement to rent a property for less than one month is not a ‘rental agreement’

Question 23

What do all the following have in common in relation to the PRA’s supervisory statement in September 2016, entitled Underwriting standards for buy‑to‑let mortgage contracts:

Corporate lending.

Applications from an existing borrower for consent‑to‑let

A buy‑to‑let mortgage contract with a term of 12 months or less

Existing buy‑to‑let customer re-mortgaging without additional borrowing

Answer 23

All are excluded from the requirements outlined in the statement

Question 24

The PRA buy‑to‑let regime requires lenders to assess the affordability of a buy‑to‑let mortgage contract with three main methods: The interest coverage ratio, the income affordability test and the interest rate affordability stress test

Tell me about each

Answer 24

The Interest Coverage Ratio:
The ICR (or ‘RENTAL COVER RATIO’) is the ratio of rental income to mortgage payments and associated costs and tax. PRA sets the minimum standard as 125%

Income Affordability Test:
Used where the borrower will use personal income to support the mortgage. Works in the same way as FCA regulated mortgages.4

Interest rate affordability stress test:
Like the FCA, the PRA requires the lender to factor in interest rate increases when assessing affordability.

Question 25

The PRA requires lenders of BTL mortgages to factor in interest rate increases when assessing affordability (stress test)

Tell me what the PRA requires

Answer 25

The lender must consider rate increases over a minimum period of five years from the start of the mortgage (if mort is less than 5 they obvs dont).

When deciding the rate to use, the lender must take in account of market expectations and the latest Financial Policy Committee (FPC) recommendations about the rates that should be used..

The minimum increase to use is 2%, and the minimum future rate to use is 5.5%. For example, if current rates are 3%, the minimum rate to use would be 5.5% (because adding 2% to the current rate would not equal the minimum 5.5% future rate) . However, if current rates are %, the minimum future rate to use would be 6% (Do not confuse this with the FCA’s stress test requirements of lenders for FCA regulated mortgages)

Question 26

For PRA regulated BTL mortgages where an individual has four or more buy‑to‑let properties, the lender is required to consider the borrower’s general experience as a landlord, their existing portfolio, overall wealth as well as other general factors the PRA requires to be taken into account (ie The Interest Coverage Ratio, Income Affordability Test, Interest rate affordability stress test). True or false?

Answer 26

TRUE

Question 27

How is rental income taxed for individual BTL landlords?

Answer 27

Rental income is taxed as non‑earned
income at the rate applicable to the owner’s tax band.

The income is taxable in the tax year it is received, regardless of whether the owner takes the income or leaves it in the business account

Question 28

Tell me the allowable expenses that can be deducted from rental income for individual landlord (ie so the landlord can reduce their tax liability)

Answer 28

Repairs/maintenance

Insurance

Letting Agent Fees

Ground rent and service charges ( For leasehold property)

Actual costs of replacing furnishings (wear and tear)

Question 29

Are Business BTL properties subject to CGT?

Answer 29

Yes

Personally owned BTL property is subject to capital gains tax (CGT) on sale on any gains above the annual exemption. CGT is payable within 60 days of the
transaction

NOTE: SDLT can be claimed as a purchase expense against capital gains tax.

Question 30

Tell me the advantages and disadvantages of owning your BTL property via a special purchase vehicle

info about SPV can be found in TOPIC 2.

Answer 30

Advantages: Changing ownership is simple, as SPV shares can be sold to a new owner without
the property being transferred

Tax incentives: When transferring ownership of the property via shares only stamp duty of 0.5% of the value of the shares transferred is payable…If the property itself were transferred to a new owner like in normal situations, SDLT of a much higher amount would be payable

Companies can claim expenses not available to
individual landlords

Shareholders (the owner(s) of the property) are free from the properties liabilities as this is covered by the limited company, the SPV. (saying this, most times, the directors of the SPV are also shareholders and lenders normally require a guarantee from the directors against their own property to cover the loan)

Disadvantages: There are less lenders who will
consider lending to a BTL SPV because of the work and expertise required. In turn this makes SPV mortgages more expensive

Accounting and administrative requirements for limited companies is far more difficult than more individuals

Most lenders require personal guarantees from directors to support the mortgage so directors are not free from liability anyway

Question 31

Tell me the allowable expenses that can be deducted from rental income for BTL properties owned by a SPV? (ie, so tax liability can be reduced)

Answer 31

It can deduct the same as for an individual landlord which are: Repairs/maintenance, Insurance, Letting Agent Fees, Ground rent and service charges ( For leasehold property) and Actual costs of replacing furnishings (wear and tear))

However, it can also claim the FULL mortgage interest as a business expense

Question 32

Rental income for individual BTL landlords is taxed as non‑earned income at the rate applicable to the owner’s tax band.

Landlords can also pay CGT (if applicable) and SDLT

How are SPV BTL arrangements taxed?

Answer 32

SPV’s can be subject to Corporation tax, CGT and SDLT

Corporation tax – SPVs pay corporation tax on rental income (less expenses) received, the same as other companies. Deductible expenses include salary, costs to run the business and so on.

Capital gains made by a SPV are treated as trading receipts and subject to corporation tax. SPVs are not able to claim the annual CGT exemption available to individuals (a negative of this BTL arrangement)

SDLT:
If the SPV BUYS the property, the SDLT surcharge applies, as it does with other companies

Transferring ownership of the property can be done via transfer of shares. Stamp duty of 0.5% of the value of shares being transferred is payble (This is much lower than an individual transferring ownership which is one of the tax benefits of SPVs)

Question 33

How does a SPV distribute its salary/dividends?

Answer 33

It is completely up to the board of directors to decide how to distribute the SPV’s income to shareholders as
salary and/or dividends

This means that directors can decide if and when to pay dividends, allowing them to control the amount of income tax they pay.

This is a benefit over individual BTL landlord arrangements as they are taxed on the rental income directly on whatever their income tax bracket is

JUST FOR UNDERSTANDING. OBS THE INCOME OF THE SPV IS THE RENT. THAT INCOME LESS EXPENSES IS USED TO PAY SALARY/DIVIDENDS WHICH THE DIRECTORS HAVE FLEXIBILITY IN HOW THEY DISTRIVUTE. INDIVIDUAL LANDLORDS ARE TAXED ON RENTAL INCOME DIRECTLY SO THEY DONT HAVE THIS FLEXABILITY

Question 34

Tell me about how SPV pay SDLT

Answer 34

If the SPV is being used to purchase the property the SDLT surcharge applies, as it does with individuals.

However, when transferring ownership of the property it is done so by selling shares to the new owner. Because of this, stamp duty only applies to the shares being transferred at a rate of 0.5%. This is a much lower price than it would be if the property itself was being sold like with individual arrangements.

This is one of the tax benefits for SPV BTL arrangements over individual arrangements

Question 35

Ben, a London-based solicitor, has a Swiss franc foreign currency mortgage on his UK home. If the value of sterling goes down against the Swiss franc, what effect will it have on his mortgage?

Answer 35

His monthly sterling payments will increase, as will the mortgage outstanding in sterling terms

EXPLAINED: An increase in the Swiss franc would result in fewer francs to the pound, so it would cost Ben more each month in sterling to buy or exchange the required francs. For the same reason, the outstanding mortgage would increase in sterling terms, as it would require more pounds to buy the francs to pay off the capital.

Question 36

Which of the following circumstances would not be defined as a foreign currency mortgage? The borrower:

has a euro mortgage on the their Spanish family home but is paid in sterling.

lives and works in Berlin but has a UK mortgage on a flat in London.

is French, living and working in London and buying a UK property with a mortgage from a UK lender.

Answer 36

is French, living and working in London and buying a UK property with a mortgage from a UK lender.

The Mortgage Credit Directive defines foreign currency mortgages as those in a currency other than the borrower’s income or a currency different from that in the country where the borrower lives. The nationality of the borrower is not, in itself, a defining factor

Question 37

Gemma’s father, Dan, has agreed to deposit 15% of the purchase price of Gemma’s new flat into a savings account with her lender as a guarantee for her mortgage. This means that:

Dan’s savings will be assigned to the lender for as long as the lender feels it is necessary.

Dan will not earn any interest on the savings.

Dan will not have access to his savings for an agreed period.

Answer 37

Dan will not have access to his savings for an agreed period.

This arrangement means that Dan will assign his savings to the lender for an agreed period, during which he will not have access to the savings and the lender can use the funds to settle any shortfall should Gemma fail to meet her obligations. However, he will earn interest on the savings, and as long as Gemma meets the mortgage terms and conditions and maintains her payments, he will be able to take his savings at the end of the agreed period. If Gemma has problems maintaining payments, the lender may hold onto Dan’s savings beyond the agreed period until it is satisfied that the account is up to date and the problems have been resolved.

Question 38

Which of the following is true in relation to a guarantor mortgage?

The lender will consider the guarantee separately from any other financial commitments the guarantor has.

The arrangement will commit the guarantor until the earlier of the end of the mortgage term or the lender deciding that a guarantor is no longer needed.

The lender is unlikely to consider guarantors over the age of 65

Answer 38

The lender is unlikely to consider guarantors over the age of 65

The lender will need evidence that the guarantor can afford their own commitments as well as the payments on the guarantor mortgage. Guarantor mortgages tend to be short-term arrangements, with the lender looking for evidence that the borrower(s) will be able to maintain the mortgage independently within (for example) three to four years. Lenders are unlikely to consider guarantors over the age of 65

Question 39

With the Ijara method of Islamic home finance, the lender buys the property and:

immediately sells it to the client at a higher price, with the client required to make monthly payments of rent and capital to buy the property over an agreed term.

makes a ‘promise to purchase’ agreement with the borrower, who makes monthly payments of rent and capital to buy the property over an agreed term.

immediately sells it to the client at a higher price, with the client required to make monthly capital payments to buy the property over an agreed term

Answer 39

makes a ‘promise to purchase’ agreement with the borrower, who makes monthly payments of rent and capital to buy the property over an agreed term.

The Murabaha method involves the lender buying the property and immediately selling it to the client at a higher price. With the Ijara method, there is a ‘promise to purchase’ agreement and the property is transferred to the client at the end of the term, during which the client pays rent

Question 40

Under the Murabaha method of Islamic home finance, stamp duty land tax is:

not payable on the purchase.

paid when the lender buys the property and also when the property is transferred to the buyer.

paid only once, when the lender buys the property

Answer 40

paid only once, when the lender buys the property

With both the Ijara and Murabaha methods, stamp duty land tax is paid once, when the property is initially purchased by the lender.

Question 41

onathan, a higher-rate taxpayer, is buying a buy-to-let flat as an investment, and is considering the pros and cons of buying it through a special purpose vehicle (SPV). The advantage of this approach compared to buying it in his own name is that the SPV:

would not have to pay the stamp duty land tax surcharge.

can claim all mortgage interest as a business expense.

would not pay tax on any gain made on a later sale of the property

Answer 41

can claim all mortgage interest as a business expense.

SPVs have to pay the same SDLT surcharge as individual buyers, but can claim all mortgage interest payments as a business expense. SPVs have to pay corporation tax on all profits, including the sale of a property.

Question 42

Which of the following is true of the Prudential Regulation Authority’s (PRA) interest rate affordability stress test for buy-to-let mortgages?

The minimum interest rate increase to be used is 3%.

The minimum future rate to assume is 5.5%.

The test applies to all non-FCA-regulated buy-to-let mortgages

Answer 42

The minimum future rate to assume is 5.5%

The minimum increase to use is 2%, but lenders must assume a minimum future rate of 5.5%, even if adding 2% to the starting rate results in a future rate below 5.5%. The stress test applies to all non-FCA-regulated buy-to-let mortgages except those with a term of less than five years, or fixed- or capped-rate mortgages with a term of five years or more

Question 43

Which of the following is true of a typical sub‑prime mortgage compared with a standard mortgage?

Interest rates are usually slightly lower.

Arrangement fees tend to be higher.

Maximum loan to value tends to be higher.

The range of interest‑rate options is very limited

Answer 43

Arrangement fees tend to be higher.

Question 44

Which of the following is true in relation to a guarantor mortgage?

The guarantor must agree to guarantee the whole mortgage.

The guarantor must be able to afford their own commitments as well as the guarantor mortgage.

Most lenders will consider guarantors up to the age of 75, as long as they prove sufficient income in retirement.

The guarantee usually lasts for the term of the mortgage unless the lender is satisfied it is no longer needed.

Answer 44

The guarantor must be able to afford their own commitments as well as the guarantor mortgage.

Question 45

Which of the following is true of both Ijara and Murabaha methods of Islamic home finance?

The bank buys the property initially.

The term can be up to 25 years.

They require the payment of rent.

Monthly payments are fixed for the term

Answer 45

The bank buys the property initially.

Question 46

Self‑build mortgages usually provide funds for up to 90% of the cost of the land. True or false?

Answer 46

False

self‑build mortgages usually provide funds for up to 75% of the land cost

Question 47

If Joe were to go ahead and set up the SPV and later sell his shares in it, the buyer of the shares would be liable for stamp duty. True or false?

Answer 47

True

True. Stamp duty is payable on the transfer of shares within an SPV, but there is no liability to stamp duty land tax because the property itself does not change hands

Question 48

Capital gains made on sale of a property by an SPV are subject to:

corporation tax.

capital gains tax.

income tax.

stamp duty land tax

Answer 48

corporation tax.