The majority of banks, when making decisions on mortgage applications, will look at two indicators: salary and borrowing as a percentage of purchase price. On the first indicator, banks are normally willing to lend 2.5 times one's salary or 3.25 times joint salary in a joint mortgage application, while currently most banks will lend up to 75% of the property price on their best rate with penalties for higher percentages. John and Julia are getting married and decided to buy a flat to move into once they do. You have been given the following data:
- John's current salary is £39,000 p.a. and Julia's is £37,500 p.a. plus a bonus likely to be around £5,000 (based on previous 3 years experience);
- Both have jobs where they partly telecommute, so on average each works from home 2 days a week;
- Their total savings at the moment are £25,000;
- John owns a flat which he would sell, and has been advised that he should be able to sell it for £150,000. The mortgage outstanding on this flat is £112,000;
- John and Julia are planning to apply for a 25 year mortgage;
- The average price of flats in the area they would like to move into is as follows: studios £150,000; 1-bedroom £220,000; 2-bedroom £325,000; 3-bedroom £450,000; 4-bedroom £600,000
- Having contacted a financial adviser, he has identified the following as the best available mortgage rates:
Repayment fixed rate for 2-years of 3.69%. After that period, the rate reverts to the bank's standard variable rate, which currently is 5.7%;
repayment fixed rate for 5-years of 4.29%. After that period, the rate reverts to the bank's standard variable rate, which currently is 5.7%;
interest only mortgage at 5% for the life of the loan. In this instance, you would be required to create an investment fund, which pays an interest rate of 3.9% to cover the repayment of the mortgage.
All the rates above are for loans of up to 75% of the property value. There is an increase of 1.5%age points if borrowing is up to 90% of the property value.
Assess:
a) What is the maximum John and Julia can borrow while taking advantage of the bank's best mortgage rate;
b) The amount you advise them to borrow, given their financial and professional situation;
c) Which is the best mortgage that John and Julia can take out (assume they take out the amount you recommended in b);
d) Whether that advice would change if interest rates went up or down by up to three percentage points.