U6: T23 - INTEREST-RATE OPTIONS

Question 1

Discounted‐mortgage interest rates are guaranteed not to change for a defined period. True or false?

Answer 1

False: discounted‐rate mortgages offer a discount from the lender’s SVR, so the interest rate will move up or down in line with the SVR.

Question 2

Discounted‐rate mortgages usually have an early repayment charge. True or false?

Answer 2

True: discount mortgages usually do have an early repayment charge.

Question 3

Which of the following is true in relation to a base‐rate tracker mortgage?

a) The rate is linked to the lender’s standard variable rate.
b) Any change to the interest rate is at the lender’s discretion.
c) The initial rate is likely to be higher than the lender’s standard variable rate.
d) There may be application and early repayment fees.

Answer 3

d) There may be application and early repayment fees.

Question 4

Which of the following is a feature of a typical capped‐rate mortgage but not a typical fixed‐rate mortgage?

a) An application fee.
b) Early repayment charge.
c) Variable monthly costs.
d) Overpayment facility.

Answer 4

c) Variable monthly costs.

Question 5

One feature of flexible mortgages is that interest is calculated on a daily basis. True or false?

Answer 5

True: the benefit of the daily interest calculation is that any early payments or overpayments immediately reduce the interest charged.

Question 6

The Prudent Building Society is offering a flexible mortgage with a maximum loan‐to‐value lending limit of 80 per cent. Will and Grace are looking to borrow an initial £130,000 on a property valued at £220,000; this figure is well within their assessed affordability. One of the attractions of this mortgage is that Will and Grace can draw down further funds to finance a holiday home later on with minimal administration.

How much can they draw down, assuming they passed the lender’s affordability assessment when drawing down the funds?

Answer 6

Will and Grace can draw down a further £46,000, which will take them up to the 80 per cent limit. The lender will need to make sure they can afford the increased payments if they do take extra funds.

Question 7

Bob and Luka have an offset mortgage with an outstanding balance of £120,000 and a current interest rate of 4 per cent. They have no savings linked to the mortgage at the moment but they do have £20,000 in an investment account with a local building society, earning 2 per cent gross. Their financial adviser has suggested that they move their savings into a linked offset account.

Comment on this advice, giving facts and figures to support your position.

Answer 7

Bob and Luka should seriously consider taking their financial adviser’s advice. If they move the £20,000 into the offset account, they will pay mortgage interest on £100,000. This will save them £67 a month in interest (initially and increasing each month). This outweighs the loss of £33 per month gross on savings.

Question 8

A fixed‐rate mortgage will automatically switch to the latest fixed‐rate deal at the end of the term. True or false?

Answer 8

False: a fixed‐rate mortgage usually reverts to the lender’s standard variable rate at the end of the fixed‐rate term.

Question 9

A capped‐rate mortgage will always have a collar. True or false?

Answer 9

False: not all capped‐rate mortgages have a collar.

Question 10

Ellen is considering a mortgage that offers a cashback facility. Which of the following is true? The cashback received:

a) will be subject to income tax.
b) may be clawed back if the mortgage is redeemed early.
c) will always be based on a percentage of the mortgage.

Answer 10

b) may be clawed back if the mortgage is redeemed early.

Cashback is not subject to tax and could be a fixed amount or a percentage of the mortgage.

Question 11

Variable‐rate mortgages do not usually offer a portability option. True or false?

Answer 11

True

Question 12

How many times per year is the base rate set by the central bank?

Answer 12

8 times per year

Question 13

The interest rate charged on a base-rate tracker mortgage is usually higher than the lender’s SVR.

True or false

Answer 13

False

The interest rate charged is usually lower than the lender’s SVR because the Bank of England base rate is usually lower than the average lender’s SVR.

Question 14

The minimum rate at which a base-rate tracker will charge is called the?

A) Cap
B) Collar

Answer 14

B) Collar

Question 15

What are the 3 alternatives lenders have to LIBOR?

Answer 15

1. BRR (Bank of England Base Rate)
2. SONIA
3. Fixed Rates

Question 16

What is the typical reversion rate after the end of a fixed-rate term?

A) Base Rate
B) Variable Rate
C) Standard Variable Rate

Answer 16

C) Standard Variable Rate (SVR)

Question 16

What is the typical reversion rate after the end of a fixed-rate term?

A) Base Rate
B) Variable Rate
C) Standard Variable Rate

Answer 16

C) Standard Variable Rate (SVR)

Question 17

With a lender’s standard variable-rate mortgage, the interest rate will change:

A) in line with Bank rate.
B) in line with the three-month Libor.
C) at the discretion of the lender.

Answer 17

C) at the discretion of the lender.

While there is a link between the lender’s rate and Bank of England base rate, it is up to the lender whether to reflect changes in Bank rate in its own rates.

Question 18

Which of the following is true of a discounted-rate mortgage?

A) The discounted interest will be added to the loan at the end of the discount term.
B) It provides no protection against increases in the lender’s standard variable rate.
C) It provides a discount from the Bank of England base rate.

Answer 18

B) It provides no protection against increases in the lender’s standard variable rate.

The discount is a genuine discount from the lender’s standard variable rate and is not added to the loan at any point.

Question 19

The interest rate on a base-rate tracker mortgage could potentially change:

A) eight times a year.
B) 12 times a year.
C) any number of times.

Answer 19

A) eight times a year.

The interest rate on a base-rate tracker changes whenever the Monetary Policy Committee (MPC) changes the Bank rate. The MPC meets eight times a year, so the rate could change eight times a year.

Question 20

Sandra and Annie are interested in a five-year fixed-rate mortgage to buy their first flat. This is most likely to be because they want to:

A) redeem the mortgage early.
B) be able to budget in the early years of the mortgage.
C) be able to make large overpayments in the early years of the mortgage.

Answer 20

B) be able to budget in the early years of the mortgage.

Fixed-rate mortgages feature early repayment charges on redemption during the fixed-rate term, although many will allow limited overpayments.

Question 21

One difference between a standard variable-rate mortgage and a fixed-rate mortgage is that:

A) variable-rate mortgages are less likely to feature early repayment charges.
B) fixed-rate mortgages charge a lower arrangement fee.
C) only fixed-rate mortgages offer a portability option.

Answer 21

A) variable-rate mortgages are less likely to feature early repayment charges.

Lower arrangement fees are usually charged for variable-rate mortgages. Both variable-rate and fixed-rate mortgages can offer a portability option.

Question 22

What tends to happen when fixed-rate mortgage rates are low?

A) Lenders tend not to offer capped-rate mortgages.
B) New capped-rate mortgages include a collar.
C) Arrangement fees on capped-rate mortgages reduce.

Answer 22

A) Lenders tend not to offer capped-rate mortgages.

When fixed-rate mortgage rates are low, there is little point taking out a capped-rate mortgage, so lenders tend not to offer them until rates increase.

Question 23

As a result of an increase of 0.5% in Bank rate, Sam’s lender has increased its standard variable rate by 1% but Sam’s mortgage has only increased by 0.3%. This is because Sam has a:

A) tracker mortgage.
B) discounted-rate mortgage.
C) capped-rate mortgage.

Answer 23

C) capped-rate mortgage.

A tracker mortgage moves in line with Bank rate, so would increase by 0.5%. A discounted-rate mortgage gives a discount from the lender’s standard variable rate, so the increase would be 1%. A capped-rate mortgage sets a cap to limit the maximum rate that would apply. In this case the cap is 0.3% above the rate Sam was paying, limiting his increase to 0.3%.

Question 24

What tends to happen when fixed-rate mortgage rates are low?

A) Lenders tend not to offer capped-rate mortgages.
B) New capped-rate mortgages include a collar.
C) Arrangement fees on capped-rate mortgages reduce.

Answer 24

A) Lenders tend not to offer capped-rate mortgages.

When fixed-rate mortgage rates are low, there is little point taking out a capped-rate mortgage, so lenders tend not to offer them until rates increase.

Question 25

Greg has an interest-only offset mortgage with his bank for £150,000 and currently has £30,000 in a linked savings account. The current mortgage interest rate is 4.2% and the bank’s standard savings interest rate is 2%. How much interest will Greg be charged this month?

A) £420.
B) £475.
C) £525.

Answer 25

A) £420.

Greg’s linked savings would be deducted from the mortgage to work out the interest payable this month. He would pay 4.2% on £120,000, which is £420.

The £475 answer assumes he would pay 4.2% on the whole £150,000 mortgage, and that 2% interest on £30,000 would then be deducted.

The £525 answer assumes 4.2% would be paid on the whole mortgage.

Question 26

Karen and Darren have a flexible mortgage with their bank. Which of the following terms is most likely to apply?

A) Interest calculated on a monthly rest basis.
B) The right to draw down further amounts, up to an agreed limit, without a further affordability assessment.
C) The right to take payment holidays, subject to certain conditions.

Answer 26

C) The right to take payment holidays, subject to certain conditions.

Interest is calculated on a daily rest basis. MCOB responsible lending rules require an affordability assessment before withdrawal of any further funds. Payment holidays would be permitted, subject to the presence of past overpayments and sufficient credit in the account.

Question 27

Trish has an offset mortgage on a capital repayment basis. Keeping a consistent level of savings in the linked account would:

A) reduce the term of her mortgage.
B) result in a lower interest rate on the mortgage account.
C) reduce the income tax payable on her savings.

Answer 27

A) reduce the term of her mortgage.

As Trish’s monthly repayments would normally stay the same, the savings would reduce the amount of interest charged, which would in turn mean repayment of more capital each month. This would result in the capital being paid off more quickly and a shorter term. The savings would have no effect on the actual interest rate charged. No interest would be paid on her savings, so income tax would not be relevant.