The Dangers of Mortgages

Mortgage Basics

Unfortunately, in this day and ages, mortgages are virtually unavoidable for the common man. Paying rent, in my selfish capitalist view, has as much use as burning cash. And in some ways I'd prefer burning it than funding a stranger's pension pot.

Due to the current inflated prices all but the wealthiest buyers are therefore forced to get mortages. The two main types are fixed and variable rate mortgages. Fixed mortgages have fixed payments for a set number of years. Buyers typically have to pay a higher premium for this privelage. However, an inverted yield curve has led to some recent exceptions. Variable rate mortgages have payments that vary with the current base rate. Unfortunately these are susceptible to lenders raising payments in the event of a rate increase, but failing to pass on the saving if rates fall.

Things to avoid

There are certain mortgage options that are generally wise to avoid. A home is a very expensive investment and will often be an individual's largest asset. It is therefore important to take extreme care before signing up for anything.

Mortgage Payment Protection Insurance

Mortgage Insurance claims to cover buyers' mortgage commitments in the event of illness, unemployment etc... However, they are frequently accused of being overpriced and containing too much small print. There have also been numerous cases of individuals being unable to claim on these policies due to the small print. Certain investigations have found that these policies are often less then worthless. An acquantance recently told me how one policy offered to him would have added over 5% to his monthly payments, and that is obviously a poor deal when you consider that kick in until 6 months of unemployment had ellapsed. I personally wouldn't bother with this due to the expense, complexity, and unlikely event of a successful claim should I need it. If you want to be cautious put the quoted insurance premiums into your own high interest savings account. Use the savings for payments if you lose your job and accumulate interest in the mean time.

Interest Only Mortgages

Interest only mortages have also become a fad, particularly with the get-rich-quick buy-to-let crowd. The general idea behind these products is that buyers do not repay the capital on their loans - only the interest. This gives lower individual repayments, but leads to an indefinite increase in the term of the loan. Interest only mortgages are popular because short time property speculators aim to buy and sell properties at minimal cost. However, any delay in renovations or the sales process could seriously jeapodise the buyer's liquidity. Also, a failure to make a profit on a speculative property could leave the speculator with a mountain of debt. It is therefore only advisable for more experienced investors to use this particular mortgage product.

Consider Estate Agent's estimates wuth a pinch of salt

I recently viewed a property in Balham, South London. It was next to a train line and the sellers were asking for £375k. The Estate Agent estimated that it would take 6 months and cost £60k to renovate, upon which its value would be £450k. So, looking at the financial side of this transaction, the Estate Agent estimated that I could make a £15k profit on a £425k investment over 6 months. That equates to a 3.3% profit target over a 6 month period. "Hardly arbitrage", was what I was thinking, especially when you consider stamp duty, solicitors feeds, estate agent inflated estimates, estate agent fees and other costs. I really wonder if he wanted me to buy it or just let him go to the pub. Anyway - the moral of this story is to make sure you do your sums and to treat anything the estate agent says with a pinch of salt. If you aren't geting a significant return on top of the base rate you're better of putting your cash in the bank.

Choose the right type of interest rage

The main two types of interest rate are fixed rates and variable rates. Fixed rates are typically fixed for a certain period. They then usually move to a lender's variable rate, though they can be refinanced onto another fixed deal. Variable rates will vary with a base rate, such as the Bank of England base rate. Home buyers need to be aware that their mortgage repayments can therefore change. And the current low interest climate in combination with interest only mortgages could leave a lot of people exposed in the near future. So before you take out a mortgage, make sure that you know you'll be able to survive an increase in rates.

This article is based on the author's opinion and does not constitute financial advice. The author is not liable for the results of any decisions made as a result of reading this page.