1. Certificate for Introduction to Securities & Investment (Cert.ISI) Unit 1 Lesson 52:  Mortgages 52cis

2. Characteristics of the UK property market In the UK, the proportion of families who own, or are buying their home, is higher than in many countries in the European Union

3. Characteristics of the UK property market Over the past 30 years, the proportion of the British population owning their own homes has increased from about 50% to about 70%. A house is the largest single investment that most Britons make in their lifetimes

4. Ownership profile of the UK property market Number of Homes There are just over 26 million properties in the UK Home Ownership In the UK approximately 70% of these properties are partly owned with a mortgage lender, or owned outright. The rest are owned by social landlords such as Housing Associations.. Ownership Breakdown Of the 70% of homes owned privately (approximately 18.2m), it is estimated that a third (approximately 6m) of these are owned outright, without a mortgage. Number of Mortgaged Properties This leaves approximately 12m properties part-owned and part-mortgaged, meaning fewer than 50% of the 26m homes in the UK are mortgaged.

5. UK property market – buying, selling and renting Buying and Selling Market Approximately 1.2-1.5m homes are bought and sold every year in the UK, except in 2008 when due to the credit crunch, sales fell to an all time low of around 800-900,000 transactions. Part Exchange This is where a company or builder buys a property from a seller, while selling them another property. Prevalent in the new build and retirement market. Renting and Letting Market This is an increasingly important market, with as many people renting during the year as buying/selling. There are approximately 1.5 to 2m properties rented privately every year, ie not through a Housing Association owned property.

6. Assessing the credit risk of a mortgage borrower A mortgage lender will consider each loan application in terms of the credit risk – the risk of not being repaid the principal sum loaned and the interest due:  Borrower’s income and security of employment  A borrower with a track record of changing jobs every six months would not be a good credit risk  Borrower’s existing outgoings – can he / she afford the monthly payments?  Utility bills, credit-card repayments, care-home fees for elderly parent etc, could consume most of the borrower’s disposable income  The size of the loan in relation to the value of the property being purchased  If the borrower is able to put down a 30% deposit, the lender has much more certainty that the loan will be repaid  If the loan is 95% of the value of the property, it would take only a 10% fall in property prices for the borrower to have “negative equity”

7. Repayment or interest-only mortgages? Mortgages can be either repayment mortgages or interest-only mortgages  A repayment mortgage is structured so that the capital sum borrowed and the interest will be repaid over the life of the loan  Most of the interest is paid off in the first half of the life of the loan  The life of the loan is typically 25 years  The key feature of a repayment mortgage is that – provided all the payments are made – the borrower is guaranteed to own the home outright at the end of the term of the loan Interest-only mortgages is that they require smaller monthly payments  Sometimes the home-buyer can only afford an interest-only mortgage  Each monthly payment comprises both interest and principal (i.e. the capital sum borrowed) Illustration of mortgage repayments on a 25-year, £150,000 mortgage with a 10% interest rate o But the proportion varies over the life of the loan

8. Interest-only mortgages The other form of mortgage is an interest-only mortgage. The borrower makes a monthly payment to the lender  Borrower pays only the interest  The borrower is expected to put money aside each month to cover the repayment of the capital at the end of the loan period  Borrower may put the money into other investments, such as the stock market  The borrower may have decided that the stock market offers better potential for capital growth than the property market  During the property market boom, many borrowers had no intention of holding onto the property for the full term of the loan and were counting on the property market rising fast enough for a “quick turn” Not all borrowers take interest-only mortgages because they can’t afford the full repayment mortgage monthly payments

9. Mortgage interest charges Variable rate  Borrower pays interest at a rate which varies with the market  The Bank of England base rate heavily influences the mortgage interest rate market  When rates go up, the monthly repayment will go up, and vice versa Fixed rate  The interest rate is fixed for the first few years (normally 3-5)  If interest rates in the market go up, the borrower is protected, and continues to pay the lower, fixed rate of interest  If interest rates fall, and continue to stay low, the borrower is stuck  The borrower can only get out of the deal by paying a redemption penalty to the lender o The penalty compensates the lender for the loss of interest payments  Fixed-rate borrowers are usually required to remain with the same lender after the end of the fixed-rate period. This is known as the “lock-in” period.  The borrower then has to pay the standard variable rate for a few years.

10. More mortgage interest rate charges Mortgages are profitable business for the banks  Mortgage brokers earn commission from banks by sourcing borrowers for them Capped rate  Capped mortgages protect borrowers from rates rising above a particular rate – the capped rate  Example: borrower pays the current variable rate of 6%, capped at 7% o If the variable rate falls to 5%, the borrower pays that lower rate o If the variable rate rises to 8%, the borrower pays just 7% Tracker rate  The mortgage interest rate is linked to another rate (usually Bank of England base rate)  Tracker rate is set at a fixed percentage above the BoE rate, say 1%  Tracker rate will increase and decrease as BoE rate changes o It “tracks” the BoE rate

11. Mortgage servicing Servicing the mortgage is the biggest monthly outlay for most families When a borrower is failing to meet his/her monthly payment, the mortgage is described as being “in arrears”  At present, in the UK, 1.64% of all mortgages are in arrears Repossessions as a proportion of all mortgages remains steady at 0.09%.  About 10,000 properties are re-possessed each quarter in the UK. Assume home-owner pays a deposit of 25%: mortgage required is £253,000 The average salary of £24,000 provides a monthly income of £1,540 after tax and National Insurance That is not enough to service the cost of a repayment mortgage for an average house in Bromley

12. Mortgages Mortgages are the most common types of secured loans A mortgage is a loan, secured on the property it is financing  If the borrower defaults (i.e. stops repaying the loan and/or paying interest), the lender can re-possess the property  Any money left over after repayment of the outstanding loan is returned to the former property owner  The property is then sold by the lender (often at auction) and which then reimburses itself with the proceeds

13. Second mortgages Some people take out a second mortgage on their property to finance other property investments:  Perhaps to buy a second home in the UK  For holidays  Somewhere to live during the working week  For investment (e.g. buy-to-let)  Perhaps to buy a holiday home overseas  Perhaps to renovate or extend their main home If the borrower defaults, and the property is re-possessed and sold, the first mortgage is reimbursed before the second

14. Second homes In 2005, the Office for National Statistics estimated that approximately 1% of homes in the UK are second residences. The number of second homes in England rose by 2.6% in 2009 following a contraction in 2008 of -0.4%. This rise, which equated to 6,212 additional second homes, pushed the total to an all-time record of 245,384. Holiday homes account for 50% of these. Number of second homes owned, 1994 - 2005 Source: Office of National Statistics The number of homes owned by UK citizens abroad has also been increasing steadily Although this is only a small percentage overall, the proportion of second homes in some Local Authorities areas is significant. Second homes make up around 10% of households in some areas of the West Country, with some having as many as 26% second homes. Expensive flats in Brixham dominate the harbour, Many are unoccupied in winter

15. Number of private rented properties in the UK3.2 million Number of private rented households3.1 million Total number of Buy-To-Let mortgages1.2 million Total value of outstanding BTL mortgages£145 billion Buy-To-Let mortgages in arrears2% Source: Axis Property Investment Rental levels in UK major cities Buy-to-let mortgages Period Number of new BTL mortgages Value of new BTL lending Percentage of new lending by value 200993,500£8.5bn5.9% 2008222,700£27.2bn10.7% 2007346,000£44.6bn12.3% Buy-to-let lending represented only 5.9% of all lending in 2009 (10.7% in 2008), but the total value of outstanding buy-to-let loans still represented around 11.8% of the mortgage market despite the recent shrinkage in new business.