Finance

Mortgage FAQ - Basic Guide to Mortgages

Basic Guide to Mortgages:

1. What is a Mortgage?
2. Where can I get a Mortgage?
3. What are the main types of Mortgages?
4. How do I repay my Mortgage?
5. How much money can I borrow?
6. What other costs are associated with buying a property?
7. What grants, tax-relief's and benefits are on offer to me?

1. What is a mortgage?
The word mortgage literally translated from old French, means 'dead pledge'. Today it is universally understood to mean a loan secured against property.

When you take out a mortgage with a lender, you enter into an agreement, through the signing of contracts,to give the lender a first charge over your property. This means that the lender must be paid back first if the property is sold.

If you breach the terms and conditions of a mortgage contract, for example, by not repaying to lender, the lender is entitled under the deed of mortgage to make an application to the courts. This may result in the re-possession and sale of the property in order to pay off the debt, however, this course of action is normally only taken as a last resort.

2. Where can I get a mortgage?
You can obtain a mortgage from a number of sources including banks, building societies and mortgage brokers. Banks and building societies tend to sell their own mortgages, while mortgage brokers tend to sell mortgages on behalf of multiple banks and building societies.

Check out the Mortgages section of MyHome.ie for an online quote from one of the leading mortgage providers in the market.

3. What are the main types of mortgage?
Repayment Mortgage
The most straightforward form of mortgage repayment with capital and interest paid off monthly from day one. It works just like an ordinary personal loan except over a longer term.

In the early years, you repay mostly interest, with a smaller proportion of the payment being made against the loan. Over time, however, this ratio changes with the proportion of capital repayment increasing and interest reducing until the loan is paid off.

Advantages
It is simple, straightforward and easy to understand. Unlike with other mortgages, there is no risk associated with investing in the stock market. You are guaranteed to have the loan repaid at the end of the term provided all payments are met.

Disadvantages
Unlike with other mortgages, repayment loans do not give you the opportunity to benefit from a rising stock market. Also, when moving house, people usually take out a 25 year repayment mortgage each time to help keep monthly costs down. This extends the period for repaying the debt.

Endowment Mortgage
Your monthly repayments only cover the interest on the amount you have borrowed. You must also take out an endowment policy with a Life Assurance Company to which you make separate payments. In theory, at the end of the term of the loan the proceeds of the life assurance policy should be sufficient to clear the principal amount borrowed.

It is important to note that there is no guarantee that all life assurance policies will clear the principal amount owing at the end of the term of the loan. With an endowment mortgage it is advised that you contact your life assurance company from time to time to monitor its performance throughout the term of the loan.

Advantages
The policy is very flexible and can be maintained if you move house or change mortgage provider. Endowments can include some kind of life and critical illness cover, and can be cheaper than buying such cover separately. If the underlying investments perform well, you may get more than is needed to pay off the loan.

Disadvantages
If the stock market is under performing your policy may not make enough money to cover the loan at the end of the term. In order to ensure that the mortgage loan is repaid in full at the end of the agreed term you must ensure that the amount you pay into the policy is sufficient to ensure a return on your investment that will cover the remainder of the loan.

Pension Mortgage
This type of mortgage is usually offered to individuals who are self-employed. You make monthly repayments of interest on the loan to the lender. Additionally, you make contributions to a personal pension, which will provide a tax-free lump sum and taxed regular income upon retirement. Most, if not all, of the lump sum is used to clear your mortgage loan at that date.

Advantages
Pension contributions qualify for tax relief, which will increase the value of every €1 you contribute.

Disadvantages
Using your lump sum to clear the mortgage may leave you with inadequate income in retirement. Also, the lump sum is payable upon retirement, so your loan term may be more than 25 years. Poor investment performance may adversely affect the amount of the tax-free lump sum, leaving insufficient funds available to repay the loan at the end of the agreed term.

4. How do I repay my mortgage?
There are two main methods of repaying your mortgage.
You can choose to pay either a Fixed Interest Rate or a Variable Interest Rate. In addition, your mortgage provider may offer a variety of more specialised mortgages such as Discount Rate, Split Interest, Capped, Deferred, Index Linked.

Fixed Interest Rate
Loans such as this fix your monthly interest payments at a specified level for an agreed period of time such as 1, 3, 5 or 10 years. When the fixed-rate period has ended, your monthly payments change to match your mortgage provider’s standard variable rate.

Advantages
You know exactly what your mortgage will cost you in the early years. This helps with household budgeting. It also protects against increases in the base interest rate over the fixed term of the mortgage.

Disadvantages
These loans can sometimes carry early redemption penalties, which may persist long after the fixed term is over. Can be poor value for money if the base interest rate is significantly lower than your fixed rate over the fixed term.

Variable Interest Rate
This is the simplest form of loan. The interest rate is set according to the lender’s standard variable rate. With a variable interest rate mortgage your interest payments are likely to rise or fall every time there is a change in the European Central Bank base rate.

Advantages
There are generally no penalties for early redemption on these loans.

Disadvantages
Interest rate movements can be very unpredictable. This makes it difficult to plan your finances into the future, and the costs of your mortgage may increase rapidly if interest rates go up. Also, lenders do not always pass on the full change in the base rate. This can sometimes be to your advantage, but often not.

Discount Rate
This type of loan helps reduce your expenses in the early years of the mortgage by setting your interest rate at a few points below the lender’s standard variable rate. Your interest payments may still fluctuate, but the differential between your rate and the lender’s standard variable rate remains constant.

Advantages
The discount reduces the initial cost of the mortgage repayments, freeing up money for other expenses, such as new furniture, when you need it most.

Disadvantages
When the discount period comes to an end, the loan shifts back to the standard variable rate. This could mean a big jump in what you pay. There may be early redemption penalties, which will reduce their benefit if you move house early on.

Capped Rate
A capped rate loan has a fixed ceiling on the interest rate for a period of time, above which your rate will not go. However, if the base rate falls, your rate can still fall with it.

Advantages
You are protected from interest rate increases, but can still take advantage of interestrate decreases.

Disadvantages
It can be more expensive than fixed rate or discount rate mortgages and application fees may further add to the cost of your loan.

Split Interest
An agreed proportion of your mortgage is at a fixed rate and the remainder at a variable rate. If interest rates decrease, repayments on the variable part of your mortgage fall also, and if interest rates increase, only the variable payment is affected.

Advantages
Security of knowing only the variable proportion of your mortgage is affected by interest rate movement.

Disadvantages
Can represent poor value for money if the base interest rate is significantly lower than your fixed rate over the fixed term.

Deferred Start
You make no repayments at all during the first one, two or three months of your mortgage.The payments that you miss are spread over the remaining term of your mortgage.

Advantages
Frees up money when you most need it, that as, when you are moving into your new house.

Disadvantages
A deferred start mortgage may only be offered to first time buyers and generally only with repayment mortgages. Future monthly payments will be slightly higher.

Index Linked
If you increase your repayments by a set percentage, even as little as 1%, you can clear your mortgage early. You decide the percentage, and you can change it or go back to the standard repayment whenever you want.

Advantages
No penalties associated with clearing you rmortgage early.

Disadvantages
This option is generally only available with variable rate repayment mortgages.

A number of factors will determine which mortgage suits you best. These include the term of the loan, your age and health, your risk profile, your need for flexibility and what, if any, investments you hold.

New flexible mortgage products are coming onto the market all the time. Discuss with your mortgage advisor or provider which one is most appropriate for your circumstances.

5. How much money can I borrow?

Check out the MyHome.ie Mortgage Calculator

Generally speaking, you can borrow up to 90% - 92% of the purchase price of the house. The other 8% - 10% of the purchase price of the house is usually paid up front by the buyer as a deposit.

The amount your mortgage provider will lend you is based on multiples of your salary. While each lender will have its own formula for calculating how much it will lend you, a general rule of thumb is around 3.7 times your gross annual salary. If you are buying with a partner, loan entitlement will be approximately 3.7 times your combined income.

NOTE: Each lender will calculate how much it will lend you according to its own criteria.

You may be allowed to borrow more if someone, such as a parent, is prepared to act as guarantor to the loan.

6. What other costs are associated with buying a property?

There are a number of other costs, which you must factor into your budget when you are purchasing a property.

Valuation and Structural Survey Fees
Your lender will value your prospective house for the purpose of assessing it for a mortgage. This differs from an independent structural survey, which it is advised you carry out yourself to ensure that the property is structurally sound.

A valuation usually costs between €100 and €200, while a structural survey can cost between €300 and €400.

Administration Fee
Some lenders can charge an administration fee for arranging the loan. This can be 0.5% of the total cost of the home loan.

Mortgage Indemnity
This is payable if the mortgage is for more than 75% of the property's value. It covers the higher risk that the lender is taking by advancing a larger loan.

Legal Costs
Solicitors Fees
Costs are generally around 1% or 1.5% of the purchase price (plus VAT). If, however you are also selling a house, further expenses will be incurred. It is standard practice for a solicitor to provide you with a quotation on request. You are also responsible for any outlay, title deed registration fees and search fees.

Stamp Duty on Property
Get a complete guide on Stamp Duty from our finance advisors, KPMG.

Insurance Costs
Buildings Insurance
When you have completed the purchase of your property you must ensure that the property purchased is adequately insured. The house insurance premium will vary depending on the amount of cover. It is advisable to have the property insured from the day the contacts are signed.

Home Contents Insurance
It is also advisable to arrange insurance for the contents of you property to guard against the risk of theft or damage. You may also wish to insure against the temporary or permanent loss of income. This will ensure that mortgage repayments are met if you are faced with a period of involuntary employment, sickness or have an accident.

You may be required to take out Life Assurance to enable your mortgage to be paid in the event of your death during the term of the loan.

Redemption Penalties
This is a financial penalty impose by the lender on Fixed Rate mortgatges only if you wish to repay the mortgage or remortgage within the period of the discount or fix. These penalties can vary greatly from lender to lender, but the usual penalty is a payment to the lender of three months' worth of interest.

7. What grants, tax-relief’s and benefits are on offer to me?

Mortgage Interest Relief
Owner-Occupiers and First-time Buyers:

Tax relief is available on interest paid on a loan used to purchase your principal place of residence. The tax relief is granted at source. This means that the tax relief element on the mortgage interest will be “built into” your monthly mortgage repayment. Therefore, it will not be necessary to claim relief in the annual tax return or to contact Revenue.

The overall annual limits are:

Single
First-Time Buyers €10,000
All Others: €3,000

Married/Widowed
First-time Buyers: €20,000
All Others: €6,000

The higher limits for first-time buyers apply for the tax year in which the mortgage is taken out plus the six subsequent tax years.

Investors:
With respect to investors, interest relief on monies borrowed to purchase or improve rented residential properties has been restored by the Minister for Finance in the recent Budget and will apply from 1 January 2002 and can be set off against rental income for the same period. This relief had originally been withdrawn following the 1998 "Bacon Report".

Rent a room scheme
The "Rent A Room Scheme" was introduced by the Finance Act 2001. Its main aim was to increase the availability of rented residential accommodation and permitted a person to let a room (or rooms) in their principal private residence, with gross annual rental income of up to €10,000 being exempt from tax.

Room rentals coming within the scope of this scheme will not trigger a clawback of any stamp duty relief, nor will it affect full entitlement to Capital Gains Tax principle private residence relief (in the event of a subsequent disposal of the property) nor full entitlement to mortgage interest relief.