Remortgaging is undertaken for a variety of reasons:
· To replace an existing mortgage with a cheaper home loan or in anticipation of a shift in interest rates.
· To raise capital for the enlargement, improvement or adaptation of the home or for consumption (cars, holidays).
· To consolidate debts, where unsecured personal loans and credit card debts are replaced with a single loan secured on the home.
If you have reason to believe that mortgage rates are likely to rise, you may seek to replace your standard variable rate (SVR) mortgage with a fixed rate or capped rate loan.
Conversely, if you predict that interest rates will fall, then you might consider switching from a fixed to a standard or discounted variable rate mortgage, after taking all costs into account.
COSTS OF REMORTGAGING
The borrower will incur the normal mortgaging costs:
Valuation fees
Solicitors’ fees for conveyancing
Land Registry, local search fees (disbursements) and lenders’ costs
A Mortgage Indemnity Guarantee (MIG) premium where the loan-to-value is above a given ratio (e.g. 70%).
Any negative equity will have to be borne by the borrower.
Unexpected costs, such as repairs to the property (e.g. new roof, new windows, damp proofing) as a condition of the remortgage.
With discounted, capped, fixed rate and other types of “specialist” products the lender will attempt to recoup the costs of recruiting new borrowers.
ARRANGEMENT AND BOOKING FEES
An obligation to insure the property and contents with a policy from a specific provider, for which the lender receives a commission.
Early redemption penalties on the old mortgage calculated as a percentage of the outstanding balance at redemption. The term over which the penalty becomes payable often extends beyond the concessionary period, and known as 'overhang.'
In all cases, the borrower should first approach the existing lender to ascertain how far it will go to retain the mortgage business. While the existing lender may not be able to match a rate on offer elsewhere, you may be able to persuade it to reduce or waive valuation, arrangement and booking fees. Furthermore, you may not incur legal costs and other disbursements if you stay with the same lender.
DOING YOUR HOMEWORK
Before you commit yourself to a remortgage, you need to have the following information:
A written redemption statement with the official settlement figure. This will show any early redemption penalty and other sundry charges like a “sealing fee”.
Legal fees, valuation fees and other disbursements
The month-by-month savings, including any in the overhang period.
DOING THE SUMS
A remortgage is not necessarily worthwhile if savings simply exceed total costs over the term. Most remortgaging costs are incurred at the start, whereas the benefits accrue over time. The calculation is therefore a ‘discounted cash flow’ (DCF) exercise, where £1 accruing in the future is valued at less than £1 in hand.
The upfront costs consist of the legal fees and disbursements, arrangement and booking fees, early redemption penalties and valuation fees. Future benefits need to be set against present costs in order to calculate an 'internal rate of return.'
This DCF method can be used to evaluate a remortgage offer or to compare different offerings by internal rate of return (r). The calculation can be performed on a special financial calculator like a Texas Instrument BAII Plus or a Hewlett Packard HP 12C.
EXAMPLES:
(a) You are coming to the end of a 3-year discounted endowment mortgage of £120,000. The penalty period is the original 3 years plus another 2 years overhang. You are currently paying 5% p.a. but this will rise to 6.3% SVR at the end of the concessionary period.
You have been offered an alternative 2-year fixed rate mortgage at 4.5% reverting to an SVR for 2 more years (currently 6%), However, you intend to remortgage again at the end of the initial 2-year term. This offer looks pretty good especially as you expect mortgage rates to rise by 0.25% in 3 months time.
Your redemption statement shows a 2% early redemption penalty on the outstanding balance. The new mortgage lender wants a £395 arrangement fee and a booking fee of £100. Your valuation fee is £200 and your legal and search fees come to £400. However, the lender requires you to take its buildings and contents insurance package which works out £20 a month more than your existing policy. Is this a good deal?
Your upfront costs are:
Early redemption penalty: £2,400
Arrangement and booking fees: £495
Valuation Fee: £200
Disbursements: £400
Total: £3,495
Ongoing savings are:
Interest: £180 p.m. for 3 months [i.e. (6.3% - 4.5%) X £120,000/12], followed by £205 p.m. for 21 months [i.e. (6.55% - 4.5%) X £120,000/12]
Less additional Insurance costs: £20 p.m.
The internal rate of return ('r') is 1.83% p.m. or 24.3% p.a. You could proceed with the remortgage as the cash flow advantages outweigh the costs of setting up the remortgage by more than any interest that you can earn on the £3,495 spent upfront. Overhang has been ignored in this case because the borrower intends to remortgage in two years time. It is not necessary to enter the early-redemption penalty on the new mortgage as it will form part of the calculation relating to the remortgage in two years time.
(b) Now assume that the repayment savings are £150 p.m. for 24 months.
The internal rate of return is now only 0.238% p.m. or 2.9% p.a. The conclusion is that this might not present a good deal if you intend to remortgage again in two years, because you can currently earn more than this rate (after tax) on £3,495 deposited in an internet interest-access savings account.
Aug 2005
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