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TheMoveChannel.com | Flexible Mortgages

Introduction

The feature of a flexible mortgage from which they derive their name is the ability to accelerate or slow down your repayments to suit your lifestyle. This means that you can take actions such as depositing your annual bonus into your mortgage account to reduce your mortgage debt, or take a payment holiday if you have to go on maternity leave, for instance.

This aspect of mortgage products has been given broad appeal by changing employment patterns that now seem to favour short-term contracts and performance-related pay, as opposed to the steady 'job for life' ethos that prevailed in previous decades. People are now much more inclined to take career breaks and almost half of all UK workers now take home a variable amount of income each month. Many millions of workers are also now getting some form of an annual bonus.

Flexible mortgages do not constrain people in such situations to paying a fixed amount each month, thereby allowing them to maximise or minimise their mortgage contributions depending on their circumstances at the time.

Flexible mortgages may seem like a new phenomenon. In a way they are, but some of the features that contribute to a mortgage being called flexible have been around for years. What is new, is that recently these features have started to be combined into specific mortgages, which are then packaged and marketed very much as lifestyle products.

They originated in Australia and first appeared on these shores in mid 1990's, but by the start of 2002, there were over 70 lenders offering flexible mortgages of one form or another, the majority of which are either high street or direct lenders. Flexible mortgages now account for somewhere around a third of all new mortgage business.

As well as growing in terms of the number of lenders offering such lifestyle products, flexibility has also broadened in terms of their effect on other types of mortgage. While 'true' flexible mortgages are almost always found with variable rates, some features of flexible mortgages can increasingly be found with other mortgages. This is particularly the case with tracker mortgages and increasingly so with discounted mortgages and even non-conforming mortgages such as mortgages for those with an impaired credit history, buy to let investors and so on. All of this means that while lifestyle flexible mortgages have established themselves as a mortgage category in their own right, certain flexible features have now found their way into mainstream products and changed the whole face of the mortgage market.

Core Features

The ability to overpay on your mortgage combines with daily calculation of interest rates to offer the single most significant feature of flexible mortgage.

If you make regular overpayments for a period of time or a lump sum deposit on your mortgage you are reducing the outstanding balance ahead of schedule. In short, this means that if you then continue with normal repayments until the mortgage is paid of, you will reach the end of your term earlier and having paid a significantly lower total amount in interest than you would have done if you had stayed on your original repayment curve.

Any amount that you pay over and above your monthly repayment is entirely going towards reducing the mortgage debt as the interest charges are met your normal monthly repayment. This means that the capital you owe is reduced by the amount you have overpaid. As a result, the amount of interest you owe each month is reduced, as it is being calculated on a smaller amount of capital than would have been the case if you had stuck rigidly to your repayment plan. This in turn means that a smaller portion of your ongoing repayments is being used to pay off interest on the loan, while a larger amount is being used to reduce the capital, therefore speeding up the rate at which the loan is paid off. The more overpayments you make, the faster this effect works, particularly in the early months and years of a mortgage, when the interest makes up a bigger proportion of your normal monthly payment.

This effect is amplified by daily calculation of interest on the mortgage balance, which results in reductions to the calculated interest charges from the day the extra funds hit the mortgage account.

Small regular overpayments and single lump sum deposits can lead to savings in the overall interest bill ranging from just a few pounds to many tens of thousands of pounds, depending on the size of your mortgage and how aggressively you are willing to overpay your mortgage.

If a borrower overpays by £50 each month on a loan of £100,000 taken out over 25 years at 5.49%, the customer can save over £14,000 in interest payments and cut the term of the mortgage by over three and a half years. Ramp this up to a £130,000 loan and an overpayment of £200 each month on a slightly higher but still realistic rate of interest such as 6.2% and the mortgage could end up being paid off 8 years early with savings of nearly £50,000.

Because borrowing almost always costs more than saving, it is usually well worth homeowners who have relatively poor-paying savings accounts instead putting their money into their flexible mortgage. They benefit from instant interest savings on their mortgage, whilst still retaining the right to re-release the money in the future.

Some people are put off from flexible mortgages by the fact that they can find more attractive heavily discounted headline rates elsewhere. Flexible mortgages don't always offer the most competitive rates, but in the long term they can save offer greater savings by making your money work harder for you, as well as offering various features that you may be grateful of should some unforeseen circumstance befall you.

Other Features

Different lenders have quite different ideas about what makes a mortgage flexible and there is no single definition of what constitutes a flexible mortgage. There are at least two-dozen flexible mortgages now on offer and you would be hard pressed to find two that are identical, but they combine some or all of the following features:

Daily interest calculation

Having interest calculated daily instead of monthly or yearly can have tremendous advantages. Any overpayment that you make has an immediate effect on the outstanding balance of your debt. The knock-on effect of this is that you immediately start benefiting from the savings on the interest that is charged on the loan capital, as there is a smaller loan to charge interest on.

With an annual calculation, you don't see the benefits of the reduction in outstanding capital until the interest is recalculated. Any repayments you make are only deducted from the balance once a year, until the interest is recalculated, you are being charged interest on money you have already paid back.

Remember that the reverse is true if you underpay or pay late. With a monthly or yearly interest calculation, you may not suffer from additional interest as long as you catch up before interest is recalculated. When it is calculated daily, you immediately start falling behind schedule in terms of reducing your outstanding capital.

Some so-called flexible mortgages still calculate interest on a monthly or annual basis, due to unwillingness or inability of lenders to change legacy systems. Clearly this minimises the impact of overpaying and you should make sure that any 'flexible' mortgage that you choose calculates interest on a daily basis.

Making overpayments without penalty

You should be able to make individual or regular overpayments without penalty. Some lenders allow a limited number of annual overpayments and some set a minimum lump sum that you can overpay. These limits are put in place to ensure that the cost of administering the mortgage account does not escalate, with £500 and £1000 both being fairly common limits for lump sum overpayments. But most flexible lenders do not put such limits in place, meaning you can make regular monthly overpayments of as little as £10 or £20. Even such small amounts can lead to savings worth thousands of pounds over the life of your mortgage.

Underpayments

Many mortgages now allow you to reduce your mortgage payments for a period of time if you need to. This has the reverse effect on the interest bill to overpaying, but can still be a really useful feature if you need a break for whatever reason.

Some flexible mortgages only allow you to underpay after you have been paying back the loan for a period of time, or once you have built up a reserve by overpaying. In such cases you may only be allowed to underpay up to the amount of the reserve that you have built up. This helps ensure that you never fall behind your original payment schedule.

Payment holidays

As well as accepting underpayment, some lenders allow you to take a holiday from repayments altogether. Payment holidays vary in length, with some holidays defined by time and others letting you take a holiday up to a certain level of credit, usually either preset or derived from the length of time you have been repaying your mortgage.

Drawdown facility.

At the very least, a flexible mortgage should give you guaranteed fee-free drawdown access to any overpayments that you have made. Any overpayments are held in a reserve that can then be released if you need it. This is the equivalent to keeping savings in your mortgage account, allowing the money to reduce the interest on your mortgage.

While the money is in the overpayment reserve, it is 'earning' the mortgage rate of interest, with the added bonus that your repayment curve will be moving forward meaning lower subsequent interest charges on the entire mortgage. Some lenders do not fix the drawdown facility to be equivalent to your overpayments. Instead, they allow you to borrow back to some other level, sometimes right back up to the limit of the loan. There may be other limits on your drawdown facility, such as only one withdrawal being allowed per year, up to a fixed limit.

Valuation review

If you are using the drawdown facility to improve your home, it is sometimes possible to have the property revalued after the work is complete. If the value has increased, it may mean that you can increase your borrowing limit in line with the value of the property. Additional funds can then be raised for further work or other purposes.

Like other mortgages, flexible products can have a tiered interest rate that alters according to the LTV of the mortgage. As a result, a revaluation may lead to the loan to value ratio of your mortgage falling below the threshold for a lower rate of interest. As a result, you may find that the lower rate of interest allows you to either reduce your monthly repayments, or maintain your payments and shorten the term of your mortgage.

Payment frequency

Some flexible mortgages allow you to repay your loan in ten instalments per year as opposed to twelve. You can schedule when these payments are and this allows you to cope with shifts in earnings, or seasonal expenses such as Christmas or summer holidays. You can also sometimes choose to make your repayments weekly or fortnightly rather than monthly.

Current account facilities

Some flexible mortgages have full current account facilities that allow you to run the mortgage account as you would your normal bank account, with a cheque book and debit card. This is explained in more detail in the next section.

Redemption penalties

It is not common to find flexible mortgages with long periods of early redemption penalties. Many do still have them in the first year, however, as the lender usually tries to at least cover the set-up costs of the loan.

Term

Because of the ability to increase and reduce your payments and the effect that this can have on the amount of debt outstanding, flexible mortgages do not always run for a fixed term. You may have a target date on which the loan will be repaid, but it is not usually as rigidly fixed as with other more traditional mortgages.

Statements

When a mortgage has daily interest recalculations, you often get monthly mortgage statements as opposed to yearly ones. This allows you to gauge your progress towards paying off your loan, the size of any drawdown reserve that you may have and whether you ought to increase or decrease your spending next month to stay on track.

Current Account Mortgages

Current account mortgages incorporate all of the features of a flexible mortgage, but take the concept of overpayment to the next level. When you take out a current account mortgage, it is usually a stipulation of the loan that at least one borrower has his or her salary paid into a new current account that is taken out for the purpose of the mortgage.

This allows or forces you to maximise the overpayment effect of your income, with a potentially staggering cash flow effect on your overall interest payments in comparison to a standard mortgage.

All current account mortgages calculate interest daily on the outstanding mortgage debt. This means your salary starts working in your favour as soon as it is paid in. At that point, the outstanding balance of your mortgage debt will be reduced by the amount of your salary - usually well above the amount that you need to pay off on a monthly basis to maintain your repayment schedule. As such, your salary is acting as a temporary overpayment on your mortgage, with the size of the overpayment reducing over the course of the month as you spend your salary.

Any overpayment that is left at the end of the month continues to temporarily reduce your mortgage debt and therefore minimise the interest that is added to the account each day.

Clearly, this means that the more frugal you are, the bigger the potential benefits. Current account mortgages also offer the opportunity for further savings on your interest bill through careful structuring of your monthly expenses. If you can ensure that all your monthly bills and direct debits go out from your account immediately before your salary is paid in, then this maximises the amount of time that the each month's salary is working on your behalf to reduce the mortgage debt.

Since one of the features of a current account mortgage is the issuing of a cheque book and / or a debit card for use with the account, a fair amount of discipline is needed to get the best from the advantages that this type of set up has to offer.

Another feature of most current account mortgages is the setting up of a maximum borrowing facility with the lender, usually up to a certain percentage of the property value. This borrowing facility becomes like a credit limit for the account, allowing you to consolidate your other debts such as loans and credit cards. As long as you do not exceed your limit, these can be paid off and the balance is transferred to your mortgage account.

This facility means that you do not need to pay high credit rates of interest, with the mortgage rate usually offering a cheaper form of finance than is available elsewhere. However, many lenders do not restrict the use of such a facility to debt consolidation, bringing a temptation to use the credit limit to pay for house refurbishments, school fees, cars or holidays. While this is fine if you can afford it, you should be aware that this will have the reverse effect on your overall interest bill to overpaying. If the borrowing on your mortgage account puts you behind your normal repayment schedule, then it is likely to leave you either with larger monthly repayments or a longer mortgage term and therefore a significantly higher overall interest bill.

Offset Mortgages

Offset mortgages are a slightly different slight on a normal current account mortgage. As with a current account mortgage, an offset mortgage sees your salary paid in monthly, permits overpayment, underpayment, lump sum deposits, payment holidays and all the other features of a flexible mortgage, as well as giving you a cheque book, debit card and the facility to set up direct debits.

So what exactly is the difference?

Instead of lumping all the accounts (current account, mortgage and savings) into one and having a single balance, the different components are still kept separate from the customer's point of view.

The most obvious difference from the customer's point of view is that you are not presented with an account balance that is tens of thousands of pounds overdrawn each time you go to a cashpoint, and some people find that it is less daunting and easier to manage their affairs when they have the perception that the money is in different accounts.

Despite being held separately, the current account and savings accounts still work towards reducing the mortgage debt. However, unlike a current account mortgage, the three different accounts are not usually charged at the same rate of interest.

Some lenders charge a set rate of interest on the current account and the savings account, while others will 'sweep' the marketplace and apply the best rate of interest that can be found for each particular component. The balance in the two accounts is then added together and the total is then offset against the mortgage.

This essential means that interest is then calculated on the mortgage debt minus the balance in the other two accounts, in much the same way as a normal current account mortgage. Since it is not normally possible to find savings or current accounts that pay a rate of interest as high as the Standard Variable Rate on a mortgage, the differing interest rates is likely to represent a weakness in this type of loan in comparison to an all-in-one current account.

Flexible Buy-To-Let

Offset mortgages are a slightly different slight on a normal current account mortgage. As with a current account mortgage, an offset mortgage sees your salary paid in monthly, permits overpayment, underpayment, lump sum deposits, payment holidays and all the other features of a flexible mortgage, as well as giving you a cheque book, debit card and the facility to set up direct debits.

So what exactly is the difference?

Instead of lumping all the accounts (current account, mortgage and savings) into one and having a single balance, the different components are still kept separate from the customer's point of view.

The most obvious difference from the customer's point of view is that you are not presented with an account balance that is tens of thousands of pounds overdrawn each time you go to a cashpoint, and some people find that it is less daunting and easier to manage their affairs when they have the perception that the money is in different accounts.

Despite being held separately, the current account and savings accounts still work towards reducing the mortgage debt. However, unlike a current account mortgage, the three different accounts are not usually charged at the same rate of interest.

Some lenders charge a set rate of interest on the current account and the savings account, while others will 'sweep' the marketplace and apply the best rate of interest that can be found for each particular component. The balance in the two accounts is then added together and the total is then offset against the mortgage.

This essential means that interest is then calculated on the mortgage debt minus the balance in the other two accounts, in much the same way as a normal current account mortgage. Since it is not normally possible to find savings or current accounts that pay a rate of interest as high as the Standard Variable Rate on a mortgage, the differing interest rates is likely to represent a weakness in this type of loan in comparison to an all-in-one current account.

Right for me?

While most people would benefit from some of the features of a flexible mortgage, such as daily interest calculation, a full lifestyle mortgage is certainly not for everyone. Below are some factors to consider when assessing whether or not a flexible, current account or offset mortgage is right for you:

  • Almost half of all UK workers take home a variable amount of income each month, with many millions of workers also getting a monthly, quarterly or annual bonus. If you are likely to have spare cash at some point in the future or on a regular basis, than using it to contribute to your mortgage can be better for you financially than many of the other ways you have of spending it.
  • Similarly, established homeowners on a settled income who find themselves living in the comfort zone and spending well within their means often find that overpaying on their mortgage each month is one of the best uses for their spare salary.
  • The higher rates of pay that many contract workers obtain allows some of them not to work for the whole year, perhaps working for 9 months and then taking 2 or 3 months off, for example. For such people, the ability to change the terms of your repayments can be very useful.
  • 13 percent of the UK working population are self employed, many of whom often get paid in lump sums on the completion of a piece of work or contract. The flexible approach to repayment can be particularly useful in such instances, as can the drawdown facility in helping to smooth seasonal variations in income.
  • Flexible mortgages are particularly appealing to those with a long-term view of their mortgage. The benefits of flexible mortgages can be seen most clearly over the life of the product. If you are keen to find short-term savings, then it may well be best to look at some of the alternatives.
  • If you think it is likely that you will want to trade up to a more expensive home in the future, the option of overpaying can help you increase your equity in the home more quickly, thereby giving you a larger deposit when it comes to moving.
  • This type of home loan can have a strong appeal if you are considering a career break at some point in the future, but do not wish to lose your homeowner status. A flexible mortgage allows you to start budgeting early and overpay, so that you can afford to take time off from your repayments at a later date.
  • Other borrowers may foresee the likelihood of extra expenses in the future, such as the cost of raising children, extending their house, adding a conservatory or starting a business. The built-in credit facilities or valuation review can provide a relatively low-cost method of obtaining finance for such eventualities.
  • Some borrowers that are planning for retirement and who don't have a lot of monthly expenses enjoy the option of reducing their mortgage debt while in a relatively cash rich financial position.
  • In certain circumstances, the features of a flexible mortgage can be of particular benefit for buy to let investors, as outlined on the previous page.
  • Current account or offset mortgages offer a neat solution for homebuyers who have savings in different accounts, but who are unhappy with the low returns their money is generating.
  • Current account or offset mortgages are a highly tax efficient way of paying back a mortgage, particularly for those who pay the higher rate of tax on their income. If their money was held in a savings account, the interest would be taxable at their highest rate of tax, but in a mortgage-linked account, it is essentially 'earning' the mortgage rate of interest and reducing the mortgage capital without any tax burden whatsoever.
  • Finally, for the financially sophisticated who are disciplined with the money, there is arguably no more effective a way to pay off your mortgage and minimise the overall interest bill than with a flexible mortgage.

The potential pitfalls of a flexible mortgage are such that there is sometimes a more suitable product for you:

  • Interest rates are not as low as with the most competitive discounted rates, so if you are looking for a way to minimise your payments in the short term - which a great many buyers are - it is often better to look at other options than a flexible mortgage.
  • For this reason, a flexible mortgage is likely to be unsuitable if you are unlikely to take advantage of the different features that it has. If you are never likely to overpay or deposit a lump sum, then there will be little financial benefit in taking out such a mortgage as the rate of interest can usually be beaten elsewhere.
  • Flexible mortgages, and current account or offset mortgages in particular, require a certain amount of financial discipline if you are to get the most out of them. If you don't feel confident that you can always spend within your monthly budget, then the more rigid approach of a traditional mortgage may be more suitable. A flexible mortgage is not best used as an emergency source of cash when your salary runs out near the end of the month.
  • If you are the sort of person who often only pays off the bare minimum from your credit card bill, you may also be better off with a more rigid loan. There is not such a pressure to make a certain level of repayments with a flexible mortgage and as has already been stated, underpaying can end up costing you a small fortune in the long run.
  • Similarly, if you are likely to overuse the drawdown, underpayment and payment holiday features, this can cause serious problems down the line. Such features can end up being expensive in terms of the long-term interest payable on the mortgage as they are essentially adding to your mortgage debt in real terms - something that can hit you hard should interest rates rise before you make up the difference by overpaying.
  • Many advisors prefer not to recommend flexible mortgages to younger first time buyers, due to their relative unfamiliarity with making regular payments on a mortgage. Another reason that flexible mortgages are not as popular recommendations for first time buyers is that they offer little genuine protection against increases in the interest rate. Given the difficulty that many young buyers have in getting on the housing ladder, many are pretty stretched financially once they have done so. Fixed or capped rates ensure that the monthly outlay is fixed at a certain level for a period of time without, regardless of what happens to interest rates in general. If interest rates go up with a flexible mortgage, you will be required to increase your repayments to stay on your repayment schedule. While it may be possible to keep your repayments at the original level, this would mean you are underpaying and therefore adding to your interest bill.