First time property buying basics – part 1

By: Tim Bennett
In the first video of his short series, Tim Bennett weighs up buying vs. renting and explains how mortgages work.

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First time property buying basics – part 1

Buying a first home can seem like a pretty daunting process. That’s why I have put together a short series for first time buyers aimed at demystifying the process and some of the jargon around it. We’ll start by considering whether it makes sense to buy a property at all.

Renting versus buying

Britain is a land of homeowners. That’s, in part, because the rental market was for many years skewed towards landlords, in a way that it simply wasn’t in other parts of Europe. Also, for many property has been a good investment and there can be a perception (fair, or otherwise) that renting is “throwing money away”. However, with property prices now so high in many parts of the country that many first time buyers are effectively excluded, it pays to give the decision to buy proper consideration as it is not clear cut. There are many factors to weigh up – here are the main ones;
So, let’s say you are a committed buyer, one of the main decisions you will face is what type of mortgage loan you will choose to help you finance the property. That is what I will focus on next.

Mortgage fundamentals

A mortgage is just a loan secured on a property. This reduces the risk for the lender, as they can seize the property should you fail to keep up repayments. However, it also makes it a relatively cheap form of finance. That said, the sum involved is usually large for a first time buyer so it is important to weigh up the various types properly.
Although the mortgage landscape can seem confusing if you are new to it, the basics are pretty straightforward once you understand the jargon. The first thing to note is that there are only really two types of mortgage – repayment and interest-only.

Repayment versus interest-only

The first of these does what it says on the tin – you commit to repay interest (on the amount borrowed) and capital over a fixed term, often 25 years. This means that if you keep up repayments, you will clear your debt to a bank, or building society, over that term.

The less common type, often only available to those with large amounts of equity (i.e. low levels of debt) these days, is the interest-only mortgage. Here, you commit to make regular interest payments but then find another way to pay off the capital you owe. Options include using equity released from other properties, if you own several, using a pension tax-free sum (subject to taking advice) and using a stock-market based vehicle to save the capital you need. All carry risks.
Given that most first-time buyers will have no choice but to take the repayment route, we’ll focus on that for the rest of this article. There is now another decision to make – what type of interest rate do you want to pay?

Fixed versus variable interest

Here is a short summary;
Again, the names pretty much describe the deal on offer here, so the key thing is to weigh up which style you will be more suited to. Fixed interest rates offer certainty about the amount you will pay, but variable rates may give you lower overall costs if you get the direction of interest rates right. The rate of interest against which your rate is pegged can vary – often it is the Bank of England rate plus an adjustment (say 1%). It will also be influenced by the size of your deposit – the more you need to borrow, the higher the rate is likely to be. As a first-time buyer, watch out for a catch that applies whether you opt for fixed or variable. Depending on what you agree with a lender, the initial deal you are offered will expire after say two, or perhaps five, years. At that point, you will usually be switched onto what is called a standard variable rate (SVR) – these are usually quite high so get ready to set up your next deal well in advance. As in so many other things these days, apathy can be expensive!

Some borrowers may be eligible for a slightly different kind of deal too – the offset mortgage. We’ll finish off by taking a quick look at how these work.

How offset mortgages work

Suitable for those with decent levels of cash savings, offset mortgage work by calculating the interest that you pay on your mortgage, by netting off the value of any savings first. That reduces your overall mortgage cost and may earn you a better rate on your savings than you could get by keeping them separate. If you are eligible for an offset mortgage, this needs weighing up.
There are plenty of further considerations for first time buyers and I will explore these in other videos within this short series. You can also discuss these points with an Investment Manager, or Wealth Planner should you want to know more about, for example, tax-effective ways to save for a deposit.