Planning pays off when looking to put roof over your head

The interest rate you pay, the type of mortgage that buyers choose, and the possibility of paying off the loan early are all factors to consider when buying a property, writes John Lowe

I don't think it would be an overstatement to say that property — and, in particular, owning it — was something of a national obsession.

It is easy to understand why: home ownership offers security and the potential to make a capital gain. Indeed, in the 10 years up to 2006, residential property prices had grown at an average rate of 12% per annum.

Sadly the downturn took hold, but there are still opportunities in the property market especially now for those with money and income. Only the fortunate few can afford to buy a home outright. For the rest of us, saving up until we had the full cost of the apartment or house we wanted to buy would be impractical.

Leaving aside the fact that it would probably take decades, we would need to live somewhere else in the meantime. 

The solution is to take out a mortgage or home loan. Such loans are secured against the value of the property being purchased and — because this means the lender faces much less risk — they are normally the least expensive type of borrowing you can undertake.

From a financial perspective, mortgages are the most important consideration when buying a property. They are not, however, the only thing you need to think about if you own — or are thinking of owning — a property.

Just as important are issues such as whether it is better to rent or buy, investing in property, property-related costs, tax, and a host of other related topics, all subjects that are covered extensively in what follows.

Taking advantage of the mortgage revolution

Please put any pre-conceptions you have about buying a home or arranging a mortgage to one side. The truth is:

  • Your home is not necessarily your most important investment
  • Your home is definitely not your most expensive purchase
  • You don’t have to take 25 years-plus to pay back your mortgage. Also, and this is crucial to keeping the cost of buying your home or investment property to a bare minimum
  • The interest rate your mortgage lender charges you makes a huge difference to the cost of buying your home
  • The type of mortgage you have also makes a huge difference to the cost of buying your home. Changes in the mortgage market have meant that for the foreseeable future, you may be tied to the lender from whom you originally got your mortgage. For this reason, it is essential that you do careful research before selecting a particular lender or product. Independent advice from an authorised adviser will stand you in good stead over the whole term of your mortgage. Not necessarily your most important investment. Definitely not your most expensive purchase. Received wisdom has it that the most important investment most of us will probably ever make is in our home. There is no doubt that owning your home is a significant part of being financially secure
  • The cost is not dissimilar to renting a home — making it a good financial decision
  • You aren’t at the mercy of unscrupulous, unpleasant, greedy, or inefficient landlords
  • With luck, you’ll see the value of your property rise in the longer term — giving you a tax-free gain

Nevertheless, although it makes sense to buy your own home, you shouldn’t be fooled into thinking that it is the be all and end all of investments. It is arguable, in fact, that building up your other investments — especially a pension plan — is substantially more important.

Furthermore, the stock market has traditionally always produced a better return than property. I’m not trying to put you off buying your own home — far from it — but don’t forget it is only one part of establishing your personal wealth. It is also worth remembering that your home won’t automatically be your most expensive purchase. Depending on interest rates, that honour could easily go to your mortgage.

If you buy a house for €200,000 and take out a traditional repayment mortgage for €160,000 (80% of the purchase price) and pay it back over 25 years at an average rate of 6%, the total cost of buying your home (including interest) will be €309,265.09. That’s €109,265.09 more than the actual cost of your home. Which is why it is crucial you choose the least expensive mortgage option available to you.

Interest — all the difference in the world

The rate of interest you are charged on your mortgage makes a huge difference to the total cost of your home as the table opposite indicates:

The difference between paying, say, 3.5% and 4.5% (which doesn’t sound like much) actually equates to €18,336 of interest over the 25-year term and increases repayments by €161.12 per month.

Put another way, think how much extra you would have to earn after tax to end up with €18,336 in your pocket. Paying more mortgage interest than you have to can seriously damage your wealth. Shopping around makes excellent sense.

Although there is a whole range of mortgages to choose from, they all fall into one of two categories:

  • Repayment (annuity) mortgages
  • Interest-only mortgages

The first option is a repayment (or annuity) mortgage. With this type of mortgage, your monthly repayments are divided into two parts. The first is the interest you owe on the total amount borrowed.

The second is repayment of part of the capital you have borrowed. The big advantage of this mortgage is that you are guaranteed to have paid off your whole loan at the end of the term. However, in the early years, almost all your monthly repayments will be in interest.

Let me give you an example: Sheila takes out a €300,000 mortgage over 25 years at an interest rate of 3.7%. Her monthly capital and interest payments are €1,542.39. At the end of the first year, she will have paid a total of €18,508 but will still owe over €296,200 to her lender.

In year 10, she will have paid €185,086 and will still owe €212,000. Put another way, in the first 10 years, roughly 60% of what she pays to her lender will be interest, and only 40% will be capital.

The other sort of mortgage on offer is an interest-only mortgage. With this type of mortgage, you pay only the interest for the agreed period. With investment mortgages, you pay interest only on the amount borrowed and at the same time, you would set up a savings plan, which — it would be hoped — will pay off the capital at the end of the term. Your monthly repayments will, therefore, consist of interest on the loan and a contribution to a savings plan.

This is ideal for certain types of loans eg commercial loans, where the interest remains constant and the tax relief can be maximised (because the capital is not being repaid, you are receiving the most tax relief on the interest in the first year right through to the end of the term).

In the case of both a home and an investment property, there are certain circumstances where you might not bother with the savings element, as I’ll explain.

Around 30 years ago, interest-only home loans got a bad name because many borrowers were advised to take out endowment policies to repay the capital at the end of the term. Unfortunately, some of these policies failed to produce a sufficient return to do so. In other words, borrowers found that after 25 years, they still owed money to their lenders.

Despite past problems with endowment mortgages, interest-only home loans can make sound financial sense. For instance, if you are self-employed, the tax benefits of a pension-linked interest-only mortgage can be very substantial, in particular when taken out for commercial property.

Here is a summary of the three main types of interest-only mortgage options available:

  • Endowment mortgages: There are various types of endowment policy available: these are investments offered by life insurance companies. The money you pay to the life insurance company is partly used to provide you with life cover (so that if you die, the mortgage itself can be repaid) and partly invested in the stock market. If the money is invested well, then obviously your original loan will be repaid and you might even be left with a tax-free sum. However, if the performance of the endowment policy is not good, then you could be left with insufficient cash to repay your original loan. There is no tax relief on endowment policy premiums.In fact, this type of mortgage has not been available for many years.
  • Pension-linked mortgages: The difference between this and an endowment mortgage is that the life insurance company (after taking out money to pay for life cover) invests your cash into a pension fund. This has very definite tax benefits for anyone who is self-employed or on an extremely high income. Ordinarily, the pension fund is designed to mature on your retirement age at double the original amount being borrowed. Twenty-five percent of this pension fund is available at maturity for encashment, tax-free, and even though you will have to pay tax on the rest of the fund, you should have sufficient money to pay off the rest of the mortgage. New rules on self-direct trusts or SSAPs (small self-administered pension schemes) now allow pension funds to borrow on properties. Indeed, there are all sorts of other tax benefits available to those who buy property as part of their pension fund. Some of this is covered elsewhere in the chapters on retirement planning and tax. However, as it is such a complicated area, you will need to take specialist advice (consultation@moneydoctor.ie) if you wish to take advantage of the rules
  • Interest-only mortgages: It was possible to borrow money to purchase property at very competitive rates of interest without any obligation to repay the capital before the end of the term. For instance, if you took out a 20-year interest-only mortgage, all you have to pay each month is the agreed rate of interest. The capital sum isn’t due until 20 years have passed. This could suit you for all sorts of reasons.Perhaps you are expecting to receive a lump sum — such as an inheritance — before the 20 years are up. Maybe you intend to re-sell the property during this period. Possibly you have other investments that could be cashed in to repay the loan. Possibly you will win the Lotto! Do note that you will have to take out level term life cover that covers the entire amount borrowed for the full term in association with an interest-only mortgage, so that the loan can be repaid in the event of your death. Interest-only mortgages are now a thing of the past.

Fixed or variable rate?

As if you didn’t have enough choice already, another decision you must make when mortgage shopping can be whether to opt for a fixed or variable rate.

A fixed rate means that the amount of interest you pay is pre-set for an agreed period of time. This offers you the benefit of certainty. Even if interest rates rise your repayments will stay the same.

On the other hand if interest rates fall you won’t benefit. You incur a penalty should you wish to pay off or part pay off your mortgage while on a fixed rate of interest. Generally, this sum is set at between three and six months’ interest on the amount being repaid.

A variable rate, on the other hand, will move with the market. This is fine while interest rates are low but if they begin to rise, you could be adversely affected. There is generally no penalty if you wish to pay off all or part of the loan before the end of the mortgage term.

Tracker mortgages were the real deal, and today are costing Ireland’s lenders a fortune to maintain. The interest rate tracked the ECB rate (currently 0.00%) and the lender agreed a margin (or profit) that had to be maintained for the entire term of the mortgage; only if the ECB rate moves does your tracker rate move.

Today there are some lucky mortgagers paying 0.5% over the ECB rate (total 0.5%) as they would have negotiated their loan based on only having to borrow less than 50% of the value of their home.

Something I have become very keen on in recent years is the idea of overpaying your mortgage each month. This can’t be done with all mortgages (for instance, you can’t do it where you are on a fixed rate) but where it is possible and your income allows, it brings real benefits.

With interest rates low at the moment and potentially likely to stay low for the next few years, it may be also important to remember that if your return/yield is far greater than the cost of the money (the mortgage rate), then investing your surplus monies elsewhere may be more beneficial.

Consider these two examples, though, where overpayment can also be beneficial: Mary takes out a repayment mortgage for €250,000 with a term of 25 years at 5.5%. Her minimum monthly repayment is €1,535.22. However, she decides that she can afford to pay an extra €235 a month. 

As a result, her mortgage will be paid off six years earlier and she will save €57,070 in interest.

John also takes out a repayment mortgage for €320,000 with a term of 30 years at 5.75%. His minimum monthly repayment is €1,867.43. He ‘overpays’ by €320 a month and as a result his mortgage will be paid off nine years earlier and he will save €120,429.31 in interest!

Buying or renting? The key factors to consider

Should I buy or rent?

Ireland is one of the few countries in Europe where buying one’s home is the norm. Broadly speaking, at present, the cost of buying a home is the same as — or in many cases less than — renting the same property.

This is linked to supply and demand, of course, and varies from region to region, as well as from property to property. We were in a low-interest environment until 2006 — and this favoured house purchase, as did the availability of mortgage interest relief. Interest rates rose between 2006 and 2008, and while they are now back to historically low levels, consumers are more reluctant to borrow, and the relatively meagre tax relief for first-time borrowers has not been available to first-time buyers since December 2012 and the existing relief will finish in January 2024.

If a future government were to introduce greater tenant rights, the situation may change — but at the moment, if you can raise the deposit, buying makes better long-term sense.

After all, when you give up a rental property you receive nothing back. Whereas when you have paid off your mortgage you will own your home and may have seen a nice, tax-free capital gain as well.

House prices in Ireland rose at an unprecedented rate in the 10 years to 2007 and most informed opinion then was that as long as we continued in a low-interest environment and our economy remained healthy, a sharp fall in house prices seemed unlikely. However, things have changed dramatically over the last 11 years and prices are down 35%–40% from the 2006 peak.

How much can I borrow?

You should always put down as much of a deposit as possible when buying your home if you are a first-time buyer. You will need a minimum of 10% of the purchase price (that is to say €30,000 if you are buying a €300,000 property), but it is preferable to have more.

Why? Because it makes you less vulnerable to moves in interest rates and property values. Your ability to repay a mortgage will be based on your net disposable income (NDI) (gross income less tax, USC, PRSI and any existing loan repayments) and will be stress-tested to allow for future interest rate rises.

The maximum percentage of your NDI that can be set aside for financial commitments, including a home loan, depends on your income and can be as much as 42%. You will also have to demonstrate that on your existing expenditure pattern you have the ability to meet the stress-tested repayments on the proposed new mortgage.

This can come from a combination of existing mortgage repayments or rent, a regular savings plan and repayments from other existing loans, which will be fully paid before the mortgage is drawn down.

What is APR?

The initials APR stand for annual percentage rate and it is the way in which the cost of your loan is expressed. What makes it different from a straight interest rate is that it takes into account not just the interest rate but also the timing of any interest payments, capital repayments and other charges, arrangement fees and so forth. The APR must, by law, reflect the actual rate of interest charged over the full period of the loan.

Is it worth switching my mortgage to get a lower rate?

The short answer is it depends if you can find a new lender willing to allow you to switch. If the loan-to-value of your mortgage is less than 60%, there are two things to consider, apart from proof of ability to repay:

  • How much can you save by switching lender?
  • What is switching lender going to cost you?

The first question is easy to answer. The second question will depend on a variety of factors, including:

  • Whether you are on a fixed interest rate — in which case there may be a penalty for switching
  • How much it is going to cost you by way of legal and other costs. If you can save 0.25% a year interest — or more — it could well be worth the switch

If in doubt, consult an authorised mortgage intermediary or accountant and ask them to do the figures for you.

What if I’m self-employed?

Most financial institutions are pleased to lend to someone who is self-employed — though if you have less than three years’ sets of accounts, it may be harder. This is another instance where a professional authorised mortgage intermediary will help.

He or she will know which lenders are keen for your business and willing to offer you the lowest rates.

Remember that it is the net profit (after expenses but before tax) that lenders use for borrowing eligibility. Note: It is no longer possible to get a mortgage in Ireland without a statement from your accountant to the effect that your tax affairs are completely up to date.

What will it cost for me to buy a home?

There are various expenses in buying a home:

Valuation fees: No lender will let you have a mortgage without a proper valuation. The price of this will vary but is likely to be in the region of €130. You may like to ask an architect or some other type of professional property adviser to survey the building for you to check its condition and the likely cost of repairs. The fee for this will be linked to the amount of work required and could run to several hundred euros, or more for a large house.

Legal fees: This is primarily the cost of employing a solicitor to look after the whole transaction for you. The normal cost is in the region of 1% of the total price plus VAT at 23% and outlay. So for a €200,000 house you will have to find in the region of €2,400. Your lender may also charge you a certain amount to cover their legal fees if it is a commercial transaction.

Negotiation over legal fees is possible and you should ask for a reduction, especially if you are a first-time buyer.

Land registry fees: On a €200,000 property, these would be up to €750. The fee is to cover registering the property in your name.

Stamp duty: This is based on the purchase price of the property. The following rates of stamp duty apply to all residential properties: 1% on residential properties up the value of €1m and 2% on excess over €1m. Commercial stamp duty on non-residential property is duty rates charged at 6%.

Search fees: This is to check that the property has planning permission, isn’t located on the site of a proposed development and so forth. Usually around €150.

Arrangement fees: Some lenders charge application and arrangement fees. These could amount to between €100 and €300, but generally only apply to non-home loans.

To give you a typical example, for a first-time buyer purchasing a house for €200,000 with a 90% mortgage (€180,000) the total fees will be of the order of €4,000.

Is it worth repaying my mortgage early?

Should you overpay your mortgage each month? Should you use all your available cash to reduce your mortgage? Should you use a lump sum of cash to reduce or pay off your mortgage?

The answer is probably yes if the following applies to you:

  • You don’t have any other — more expensive — debts. (If you do, these should be paid off first.)
  • It won’t leave you without some savings tucked away against a rainy day
  • There aren’t other investment opportunities that might be worth more to you in cash terms
  • If you were thinking of paying off some or all of your mortgage, I would strongly advise consulting an authorised adviser or mortgage intermediary first. He or she will be able to work out the figures for you

What different types of home insurance will I need?

In summary, homeowners should take out the following cover:

  • Buildings insurance. This will be compulsory if you have a mortgage. Basically, it means that if some damage is done to the fabric of your home (by a fire or flood, for instance), then money is available to repair or rebuild as necessary.
  • Contents insurance. This protects you against loss of or damage to your home contents.
  • Mortgage repayment insurance (payment protection insurance). This cover is optional, but means that if you are ill or made redundant, your mortgage repayments would be paid for you.

Payments usually last for up to a year. Refunds are underway from some of the providers who mis-sold this product.

If I have trouble making my mortgage repayments, what should I do?

Contact your lender immediately. The worst thing you can do is keep them in the dark about any financial problems you may be encountering.

If you need help with your finances, you could contact a qualified, experienced financial adviser:

  • Your local St Vincent de Paul Society, which runs a special advice scheme
  • The Department of Social Protection, which also runs a free advice scheme called MABS (Money and Budgeting Advice Service)

You can obtain details from your local social welfare office or public library.

Does it make sense to buy a second property as an investment?

Buying property and renting it out became an increasingly popular investment in the 2000s. There were various reasons for this:

  • Tax incentives — you can claim 80% of any loan interest you pay on borrowings to acquire and/or improve the property, against any rental income you receive. Plus, if you buy certain types of property, or property in particular areas, you can receive additional tax breaks
  • Potential increases in property values
  • Possible high yields in relation to other investments
  • Low cost of borrowing money. In general, the only investors who don’t make money from renting out property are those who have over-estimated the return they’ll receive, haven’t allowed for all the likely costs or lack the patience to wait out any market downturns. The secrets to success are undoubtedly
  • Allow for periods without tenants (known as ‘voids’)
  • Make sure you have calculated all the costs including loan repayments, redecoration, maintenance and repair
  • Don’t view it as a short-term investment

There are various other grants available from the State including:

  • Improvement grants — a range of loans could be available from your local authority to improve or extend your home, subject to a number of conditions
  • Disabled persons grant — given to cover the cost of adapting a private home for the needs of someone with a disability
  • Thatching grant — available towards the cost of renewing or repairing thatched roofs on houses. Thatchers are a dying breed, but it is important to reward and help those who are maintaining our heritage
  • Home energy savings grants — a range of grants is available to improve home insulation, install renewable energy systems and upgrade existing heating systems to become more energy-efficient. Details can be found on www.seai.ie

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