Are longer term mortgages good news for home buyers?
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I wrote recently about a comparatively new mortgage-related phenomenon, namely the increasing propensity of mortgage borrowers to pay exorbitant redemption fees in order to transfer their loan to a cheaper competitor. Even after the redemption fees are taken into account, borrowers can save thousands of pounds if they commit to a four- or five-year mortgage term with a new, lower cost lender.
Such action is entirely understandable, but switching your mortgage every few years doesn’t always produce great results; it can be an expensive (and administrative) chore, which is why the Treasury wants to encourage more lenders to offer longer-term loans at fixed rates, similar to those widely available across the USA.
This week, a privately-owned insurance company, Rothesay Life, revealed plans to offer fixed-rate mortgages for up to 30 years to UK borrowers, thereby “helping the government’s ambition to bring mortgages to the market which offer long term certainty,” according to the company’s website.
Ultra-long term mortgages already exist: online broker Habito has offered a 40-year fixed-rate mortgage, while earlier this year London-based mortgage lender Perenna launched ‘fixed for life’ mortgages. According to the firm’s website, “Perenna aim to offer 30 year fixed-rate mortgages up to 95% LTV [loan-to-value] with flexibility to change at no extra cost after 5 years.”
So popular has Perenna’s offering been that would-be borrowers must join a waiting list before they can apply for a property loan. This is good news for Rothesay Life.
Longer-term mortgages hold particular appeal to younger people, especially those anxious to get a foothold on the property ladder, as they enable buyers to spread repayments over a period of up to four decades. Moreover, signing up for an ultra-long term mortgage can be an extremely effective means of reducing monthly outgoings, although it’s worth doing your sums before signing up.
Property values have risen significantly over the past decade, thanks in part to the ready availability of cheap money, the demand for which has been driven by historically low interest rates. Yet despite this, an increasing number of aspiring home owners would struggle to pay off a traditional 25-year mortgage. Lengthening the mortgage term offers such borrowers considerably more financial leeway.
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However (there’s always a ‘however’), although an ultra-long term mortgage is likely to be attractive to younger borrowers because it could help them get that all important toehold on the UK property ladder, it’s worth noting the longer-term cost.
For example, home buyers borrowing £175,000 over 25 years at a fixed interest rate of 2.5% would face a monthly mortgage bill of £791.52, the equivalent of £237,456 over the mortgage term.
Granted, a 40-year mortgage would reduce the monthly payments by more than a quarter, to £580.94, although over the full term, borrowers would pay £278,851, a chunky £41,395 more than the shorter term mortgage product.
In other words, while the 40-year mortgage would undoubtedly prove useful for those people keen to get on the property ladder, there is a risk that some home buyers could still be repaying their mortgage in retirement.
It follows that borrowers should take account of the advantages and drawbacks associated with an ultra-long term mortgage before taking the plunge.
As we have seen, the biggest advantage of repaying a mortgage over a longer period is a noticeable reduction in monthly costs. Not only does this makes home owning more affordable, lower outgoings cause less of a drag on disposable income.
Note too that by reducing the mortgage repayments, home buyers can theoretically acquire a larger property.
By contrast, repaying a 40-year mortgage means buyers will pay considerably more over the term of the loan than they would if they had a traditional 25-year product.
Moreover, the final repayment (assuming buyers have not paid their mortgage off earlier) is likely to be made in later life, perhaps after the date they had hoped to retire. It’s possible, therefore, that a lengthier mortgage term will affect other plans and aspirations, a point worth considering prior to committing to a long term mortgage.
It’s only fair to say that committing to an initial 40-year mortgage term doesn’t necessarily mean that buyers are burdened with it forever. Most mortgage lenders permit borrowers to overpay, which reduces both the outstanding capital and the mortgage term. In addition, once buyers have more disposable income, they’re also likely to have the option to remortgage their home over a shorter term.
On balance, longer-term, fixed-rate mortgages are likely to prove attractive to prospective home buyers; then there’s the additional benefit that borrowers will have no need to spend time hunting for better deals every few years.