Sharon and Andrew are about to have their first baby and want more flexible finances. They aim to be debt-free by the age of 50. Andrew earns £45,000 as a civil servant. Sharon will work part-time after the birth and earn £18,000. The couple have £2,500 in a savings account paying 2.1%. Andrew has £1,500 on a credit card. The couple's home is worth £240,000, with an outstanding mortgage of £70,000.
Chris Fleetwood, director at Paradigm Consulting, says the couple should put their savings into their mortgage to reduce their overall debt as the savings account has a very poor return
Sharon and Andrew are looking for a mortgage which will help them with the lifestyle changes a new baby will bring. Their key requirement is flexibility. Sharon might go back to work part-time but they must plan for the future should Andrew's salary become the only one.
The first step is to review their existing mortgage to ensure there are no early redemption penalties and to see what flexibility it provides. Then we need to look at the rest of the product range to see if there is a mortgage option which provides the flexibility they require. Apart from specialist lenders offering flexible mortgages, mainstream lenders are offering more and more flexible enhancements.
Flexibility has become a coverall for any number of products and while the Full Monty of cheque book, current account, payment holidays, overpayments, underpayments and offset sounds good in theory, many customers do not need all the facilities on offer. The factfind will be key to deciding just how much flexibility the client is expecting.
I shall assume that the client will have received advice on protecting his income in the event of accident, sickness or unemployment, and his family should he die. Andrew has a credit card debt that he should capitalise or pay off as he is paying too much for it, particularly if he is only paying the minimum amount. The fact that he is paying into a 'rainy day' account makes no sense when he is happy to service the credit card debt at a much higher interest rate than on the money he is investing for emergencies. He should pay off the credit card from the 'rainy day' pot or capitalise it.
They want to repay the mortgage by the time Andrew is 50, so we need to look at mortgages over a notional 19 years. As they are getting a poor return on the rainy day account, I would advise them to put the balance of the savings into the mortgage, thereby reducing the overall debt. Why pay money into a savings account receiving 2.1% when you get a better return by paying your mortgage off, and receive interest equal to the mortgage rate? So we are looking for a mortgage that will allow overpayments. They must be able to draw out the overpayments they have put in. Overpayments will have a beneficial effect on the eventual term of their mortgage. The more they can pay in, the less interest they will pay.
We should look at whether they want to fix repayments so they can budget or look at discounts or trackers for a lowest cost scenario. Apart from the 'fire sale' short-term discounts up to one year, fixed rates for a minimum of two years are as attractive as true discounts, particularly if we take into account the extra safety of being able to budget. I would advise fixed rates unless there is a desire for no early redemption penalties. Many lenders such as Northern Rock will allow early repayments of capital within the fixed rate term, which makes them more flexible.
The current account mortgage scenario is a good solution as well, provided the client understands he could be taking on features he might never use. Many specialist 'all in one' product providers don't have a fixed rate option and the rates can be pricey. If they don't need cheque books and offset, there are better rates and solutions in the mainstream.
Scott Mowbray, marketing manager at VirginOne, advises Sharon and Andrew to opt for an all-in-one mortgage which will give them the flexibility they need to manage their money
As Sharon and Andrew have significant equity in their property and are relatively high earners, a flexible mortgage would be a good starting point. There are many mortgages on the market that purport to be flexible, but some are as flexible as a crowbar so it is important they understand the limitations of any mortgage contract they enter into.
There are two types of mortgage I would suggest – all-in-one account mortgages offered by the likes of VirginOne and Natwest and offset mortgages offered by Barclays and Woolwich. Both types will allow them to offset money they have on deposit, in a current or savings account, with money they owe, for example a mortgage. This means their rainy day fund of £2,500 and the £150 they pay monthly into their savings account could be put to better use against their mortgage because they will be saving mortgage interest which is paid gross. So their savings are effectively earning at the gross mortgage rate.
I would recommend an all-in-one account against an offset product because they are easier to manage. An all-in-one account has one rate of interest for all savings and borrowings. An offset product may pay/earn different interest rates on different products and it is up to the customer to manage each product to get the most out of offset banking.
With flexibility being important, an all-in-one account provides a better solution than bog standard flexible and offset mortgages. They will have the flexibility to manage their money in line with their lifestyle. They can pay more one month, less the next or even take a break.
An all-in-one account will also offer the couple greater flexibility in dealing with the extra financial strain of a baby. All-in-one accounts can be used to put money aside for school/university fees so they get the benefit of this money working to reduce their borrowing and save them interest. Or they can use the existing equity in the property to put their child through school and university.
Andrew would be wise to consolidate his credit card debt at mortgage-style interest rates. The all-in-one account from Virgin will allow them to see the consolidated balance separately from the mortgage and he will be able to plan to pay it off over a sensible time period of one to two years.
An all-in-one account will offer Sharon and Andrew a better solution than anything else on the market. They are simple, flexible, will give them greater visibility of their finances and make day-to-day banking more straightforward.
A recent independent study has shown that all-in-one account customers are the most satisfied customers in UK banking.