Topic 1 unit 13- Secured and Unsecured lending

Question 1

Define Mortgagor.

Answer 1

The individual borrower who transfers their property to the lender for the duration of the loan.

Question 2

Define Mortgagee.

Answer 2

The lender (bank, building society or other institution).

Question 3

What is are Covenants?

Answer 3

A promise under the terms of the mortgage deed, as a lender’s security depends on the property being maintained in an acceptable condition.

Question 4

What is a lender permitted by law, under the covenant to insure the property adequately?

Answer 4

• Insist that a property subject to a mortgage is continuously insured by means of a policy that is acceptable to the lender;- have its interest as a mortgagee noted on the policy;- secure a right over the proceeds of any claim and to insist that the proceeds be applied to remedy the subject of the claim or to reduce the mortgage debt.

Question 5

What are the two main issues to be addressed when taking out an interest-only mortgage?

Answer 5

• Putting in place a fundraising mechanism to repay the debt at the end of the term; and- ensuring there is sufficient protection to enable the debt to be repaid should the mortgagor die before the end of the term.

Question 6

Define Personal pension.

Answer 6

A pension product that is arranged on an individual basis (ie rather than a pension scheme run by an employer). The benefits eventually received depend on the performance of the funds into which the individual’s pension contributions are invested.

Question 7

Define Stakeholder pension.

Answer 7

A simple, low-cost pension product that meets government standards on charges and levels of contribution.

Question 8

What benefits do pension plans have in comparison with endowment policies?

Answer 8

• Pension contributions qualify for tax relief at a person’s highest rate of tax, up to the annual maximum contribution limit. There is no tax relief on endowment policy premiums.- The fund in which the contributions are invested is not subject to tax on income or capital gains, meaning that it should grow faster than an equivalent endowment policy fund, which is taxed on both income and capital gains.

Question 9

What is Lifetime allowance relating to pension plans?

Answer 9

Maximum tax-privileged pension investments an individual is able to accrue during their lifetime. It effectively limits the amount of tax-free cash that can be taken to 25% of the lifetime allowance. For example the 2019/20 the lifetime allowance is £1,055,000.

Question 10

What is Minimum pension age?

Answer 10

In most cases, the minimum age at which benefits can be taken from a pension is 55, and the normal minimum pension age is expected to increase in the future.

Question 11

What are Provider restrictions relating to pension plans?

Answer 11

Not all providers offer the facility to take a taxable lump sum in excess of the 25% tax-free amount (although it is possible to switch to a provider that does). If only 25% of the fund can be taken as a tax-free cash sum, a fund of four times the loan value must be built up. This may mean that total contributions are more than the borrower can afford or more than are permitted by the pension scheme regulations.

Question 12

What is the Impact on income in retirement relating to pension plans?

Answer 12

Using a portion of the pension fund to repay a mortgage means there is less money available to provide an income in retirement.

Question 13

What is the Need for separate life assurance relating to pension plans?

Answer 13

A personal pension or stakeholder pension, unlike an endowment assurance, does not automatically carry with it any life assurance, so a separate policy will be required to cover the repayment of the loan in the event of death during the term.

Question 14

What is Assignment relating to pension plans?

Answer 14

As with all pension contracts, personal pensions and stakeholder pensions cannot be assigned to a third party as security for a loan or for any other purpose. The lender cannot, therefore, take possession of the plan or become entitled to receive benefits directly from it.

Question 15

How are ISAs used as mortgage repayment vehicles?

Answer 15

ISA managers calculate the amount of regular investment that would be required to produce the necessary lump sum at the end of the mortgage term, based on an assumed growth rate and on specified levels of costs and charges.

Question 16

What are the main benefits of using an ISA as a mortgage repayment vehicle?

Answer 16

• Funds grow free of tax on capital gains, thus reducing the cost of repaying the mortgage;- mortgage can be repaid early if the fund’s rate of growth exceeds that assumed in the initial calculations.

Question 17

What are the drawbacks of using an ISA as a mortgage repayment vehicle?

Answer 17

• If growth rates do not match initial assumptions, the final lump sum will fall short of the mortgage amount. - Should the borrower die during the mortgage term, the value of the ISA investment is unlikely to be sufficient to repay the loan. Additional life assurance cover is required to meet this eventuality.

Question 18

Outline the key features of Variable rate in terms of mortgage interest options.

Answer 18

• Monthly payments rise and fall in line with interest rate changes.- Hard to predict what future payments will be, making budgeting difficult.

Question 19

Outline the key features of Discounted rate in terms of mortgage interest options.

Answer 19

• Interest rate is a discount from the standard variable rate.- May be penalties for early repayment.

Question 20

Outline the key features of Fixed rate in terms of mortgage interest options.

Answer 20

• Interest rate is fixed for a specific period (usually between one and five years), then reverts to the standard variable rate (SVR).- Makes it easier for borrowers to budget.- May be a substantial arrangement fee and penalties or restrictions on switching to another lender.

Question 21

Outline the key features of Capped rate in terms of mortgage interest options.

Answer 21

• Interest rate is variable but cannot rise above a specified upper limit (the cap). Products that also have a specified lower limit are ‘cap and collar’ mortgages.- Allows borrowers to budget within set parameters.- Borrowers can benefit from falls in interest rates down as far as any collar limit set.

Question 22

Outline the key features of Base-rate tracker in terms of mortgage interest options.

Answer 22

• Interest moves up and down in line with (ie ‘tracks’) changes in Bank rate.- Note that a tracker rate is not the same as Bank rate - the lender’s rate will be slightly higher.

Question 23

Outline the key features of Flexible in terms of mortgage interest options.

Answer 23

• Facility to overpay, underpay and/or take payment holidays without incurring penalties.- Interest calculated on daily basis.- Options include current account and offset mortgages.

Question 24

Outline the key features of Low start in terms of mortgage interest options.

Answer 24

• Repayment mortgage with lower initial payments during which capital is not repaid.- Higher payments required after the initial period to achieve repayment of capital.- Suits borrowers keen to keep outgoings low in the early years.

Question 25

Outline the key features of Deferred interest in terms of mortgage interest options.

Answer 25

• Interest payments deferred until later in the term.- Suits borrowers who expect their income to increase over the term of the mortgage.- Not suitable for those who borrow a high proportion of the property value because of the increased risk of negative equity.

Question 26

Outline the key features of CAT-standard in terms of mortgage interest options.

Answer 26

• Charges, Access and Terms (CAT) meet standards set out by government.- Likely to appeal to borrowers who want clearly stated limits on charges.

Question 27

What basic features does a Flexible mortgage offer?

Answer 27

• Interest calculated on a daily basis.- The facility to make overpayments at any time without incurring an early repayment charge.- The facility to underpay, but only within certain parameters set out by the lender when the mortgage was arranged.- The facility to take a payment holiday, again within certain parameters laid down at the outset.

Question 28

What is a Current account mortgage?

Answer 28

This enables the borrower to carry out all of their personal financial transactions within a single account. The combination of salary credits and the calculation of interest on a daily basis considerably reduces the amount of interest payable and consequently also the mortgage term.

Question 29

What is an Offset mortgage?

Answer 29

This requires the borrower to have savings or other accounts with the lender and enables the interest payable on such accounts to be offset against the mortgage interest charged.

Question 30

Define Loan-to-value (LTV) ratio.

Answer 30

The amount of the loan in relation to the value of the asset used for security, expressed as a percentage. For a mortgage loan of £80,000 on a property valued at £100,000, the LTV is 80%.

Question 31

What are examples of stated limits on charges on CAT-standard mortgages?

Answer 31

• The variable interest rate must be no more than 2% above Bank rate and must be adjusted within one calendar month when Bank rate is reduced.- Interest must be calculated on a daily basis.- No arrangement fees can be charged on variable-rate loans and no more than £150 can be charged for a fixed-rate or capped-rate loans.Maximum early redemption charges apply to fixed-rate and capped-rate loans.- No separate charge can be made for mortgage indemnity guarantees.- All other fees must be disclosed in cash terms before the potential borrower makes any commitment.

Question 32

What rules relating to access and terms apply on CAT-standard mortgages?

Answer 32

• Normal lending criteria apply.- The borrower can choose on which day of the month to pay.- All advertising and paperwork must be clear and straightforward.- Borrowers cannot be required to buy associated products from the lender in order to receive a mortgage offer.

Question 33

What is a Mortgage indemnity guarantee?

Answer 33

A mortgage indemnity guarantee (MIG) is an insurance policy that protects the lender in situations where the loan has a high loan-to-value ratio (generally over 75%-80%). If the borrower defaults on repayments and the property is sold, the lender might not get back the full amount that it lent.

Question 34

What are Shared ownership schemes?

Answer 34

Shared-ownership schemes enable a borrower to buy a stake in the property and pay rent on the remainder. For example, a borrower can purchase a 25% stake in the property, funded by a mortgage, with the option of buying further 25% shares in the future.

Question 35

What is equity release?

Answer 35

In a mortgage context, ‘equity’ is the excess of the market value of a property over the outstanding amount of any loan or loans secured against it. Equity release plans are designed to enable homeowners who do not have a mortgage on their property to release some of the equity in order to provide capital or supplement their income.

Question 36

How does a lifetime mortgage work?

Answer 36

A lender will usually be prepared to lend up to a maximum of 55% of the property value, depending on the borrower’s age.Interest is charged at the lender’s lifetime mortgage rate, but generally no regular payments of capital or interest are made. Instead, the interest is added to the loan (rolled up). When the borrower dies or moves, the property is sold and the mortgage loan plus rolled-up interest is repaid to the lender.

Question 37

How does a home reversion plan work?

Answer 37

Home reversion plans involve the homeowner selling a percentage or all of their property to the scheme provider. The customer(s) retains the right to live in the house, rent-free (or for a nominal rent), until their death(s) or until they move into permanent residential care.

Question 38

How are equity release schemes regulated?

Answer 38

Equity release schemes, defined as lifetime mortgages and home reversion plans, are regulated by the FCA under the Mortgages and Home Finance: Conduct of Business (MCOB) rules.Anyone who advises on or arranges equity release must hold a specialist qualification.

Question 39

Define Bridging finance.

Answer 39

Can be used by those arranging a loan to finance a new purchase before they have sold their existing property in order to ‘bridge’ the finance gap.

Question 40

Define First charge.

Answer 40

A legal right to have ‘first call’ on a property if a borrower defaults on repayment of the mortgage loan.

Question 41

Define Second charge.

Answer 41

A legal call on a property after all the liabilities to the holder of the first charge have been settled.

Question 42

What is Closed bridging?

Answer 42

The borrower has a feasible plan for repaying the loan within an agreed timescale. Typically, this is through the sale of the existing property and requires the borrower to have a firm buyer.

Question 43

What is Open bridging?

Answer 43

The borrower needs finance to buy the new property, but does not yet have a firm buyer for their existing property.

Question 44

Define Revolving credit.

Answer 44

An arrangement whereby the customer can continue to borrow further amounts while repaying existing debt.