Woodruff Financial Planning blog

The Financial Services Authority (the body which currently regulates the Financial Services sector), has today launched a consultation paper on Responsible Mortgage Lending.  Their main theme seems to be that “the existing regulatory framework had been ineffective in constraining particularly risky lending and unaffordable borrowing.”

Assessing affordability for mortgages
The FSA rightly says that lenders have been too keen to allow more risky lending in the past.  This has been evidenced with self certification products, as well as ‘fast track’.

Self certification mortgages were originally designed for those people who could not prove their income such as the newly self-employed.  Fast track is still used by many lenders where the loan to value is lower than 75% of the value of the home, and the risk to them is deemed to be low.  Income is still assessed, but documents are not checked.

What ended up happening with these types of loans was that o they became so called “liar loans” – people used the system to inflate their income so that they could justify bigger loans.  Lenders were not concerned about this practice so long as house prices rose.  Of course, eventually this ground to a halt, and the practices were exposed.  Also, many mortgage brokers have been caught out supporting their clients through what is effectively mortgage fraud.

The regulator is concerned that the banks should have more robust methods for establishing affordability for loans. Therefore, they have proposed that all new lending should be assessed for affordability.  This would effectively ban self certified and fast track mortgages.

Interest only
The regulator has been concerned for some time that interest only is becoming much more widespread – probably as a result of the increasing cost of housing.  People have set up loans with no mechanism in place to repay the original capital, and this could end up being a massive problem in the years to come, as they struggle to repay this debt.

The proposal is to assess affordability as if a repayment mortgage is being taken out, even where interest only is the preferred vehicle.  We suspect that the FSA would like to outlaw pure interest only mortgages on main residences, where there is no savings vehicle in place to repay the capital.

Our view
Overall, we would broadly support more responsible lending since this would help to keep the housing market more stable, and encourage the public not to over-extend themselves financially.  We need to get out of the belief that your house is your biggest asset, since this holds back the finances of millions of people who struggle to afford bigger mortgages while ignoring other financial needs.  People need to realise that their home is not an asset in the traditional sense since it cannot be cashed in (you always need somewhere to live).

We have been worried for some time that interest only is becoming the norm, especially in younger buyers.

What all this means for the self employed is that they should seriously consider their lending needs before starting a new business, since in the future it may be very difficult to get funding for such people without full accounts, and enough income to justify the loan.

We recently reported that the Bank of England kept interest rates at 0.5% for another month.  Interest rates have been at this record low point for over a year, so we are concerned that people might get overly confident that these rates are here to stay.  However, this is unlikely as in recent years the average has been somewhere around the 5% mark. See here for more information.

The only way for interest rates is up – so you should think about this if you have a variable rate mortgage or a tracker mortgage.  If you have a fixed rate mortgage, you will be fine during the fixed rate period, but you should also think about the consequences once the fixed rate comes to an end.  Since many households fix for short periods, such as 2 years, this could come around sooner than you realise.

What does an interest rate rise mean for you?
Let’s take a mortgage of £150,000 with 20 years remaining.  If we assume that you are on a standard variable rate with a high street lender, you might be paying 3.5% (this is the Halifax rate based on today’s website).

The table below shows the effect of various interest rate rises, none of which take us up to the 5% rate which is the Bank of England’s ‘normal’ rate.

This information was provided using the calculator at Money Made Clear – an initiative provided by the Consumer Financial Education body.  Click here to put in your own details and work out the effect of interest rate rises on your personal situation.

The message here is clear – you should prepare for future interest rate rises on your mortgage and give some thought as to how you might pay the extra cost if you are on a standard variable rate mortgage.

The Bank of England today announced that they are holding the UK base rate at a record low 0.5% for a further month.

The UK base rate has remained at this low level since March 2009.  See http://www.bankofengland.co.uk/publications/news/2010/057.htm

This comes at a time when inflation has been increasing, so the assumption would be that to keep rates low encourages spending in the economy; of course, the other side of this is that mortgages, especially base rate trackers or standard variable rates, remain relatively low.  At a time of financial conservatism, keeping household expenditure down is a welcome relief for many.

A note of caution for borrowers
Some members of the Bank of England’s policy committee (the committee which decides interest rates) have been arguing for an increase in the base rate. Since the rate cannot really go down from here, and would normally be expected to be around 5%, if you are on a variable rate mortgage, you could consider whether now would be a good time to fix rates.  If you are on a variable rate, now would be a good time to seek advice on your mortgage situation.

A note of caution for savers
Inflation is now at 5.1% over 12 months, using the latest retail prices index.  If you have your money in a savings account with your bank you will probably get around 2-3% interest maximum, even if you tie in your savings for a year or longer.  This means that you may be effectively losing money.  Now would be a good time to review your savings to see if you could make your money work harder for you.

Yesterday, the Bank of England Monetary committee voted to keep the UK base rate at 0.5%, keeping rates at this record low for well over a year now.

The new Chancellor of the Exchequer is due to give his ‘emergency’ budget in a a week or so, so it was always unlikely that rates would change this month. Experts never agree on whether rates will rise, although the economy is still delicately balanced, so any changes will be taken with care. If the Chancellor increases VAT, we might expect inflation to rise (it is currently at 3.5%, which is higher than the Bank of England’s target). If inflation rises, perhaps pressure will build on the Bank to raise interest rates.

We would remind those who have come out of fixed rate mortgages onto variable rate or tracker rate mortgages, that the current levels of interest rates are historically low.  You should plan for the day when rates start to climb back up to normal levels. If you have managed to save money on your mortgage, perhaps you could consider applying some of these savings into emergency funds, or to pay off your mortgage or other debts more quickly.

Always remember that your debt is someone else’s asset.  You should work to improve your balance between assets and liabilities.  To us, assets bring you financial freedom; liabilities hold you back.

So it should not be surprising that we advocate paying off debt as quickly as you can afford, especially unsecured debt like credit cards and personal loans.  Typically, a credit card will be one of the most expensive forms of debt, yet many cards only require a 2% minimum payment each month.  This may sound like you would pay off the debt fairly swiftly – after all, 2% per month means 50 payments to repay the whole balance, or just over 4 years.  But this does not take into account the effect of the interest payments.

An Example
Let’s say you owe £5,000 on a credit card, with a typical interest rate of 20%.  Some cards have lower rates, some higher.  The minimum payment at 2% per month would be £100 per month.  How long do you think this would take to pay the balance off, assuming no further spending on the card?  The answer is 109 months, or just over 9 years!  The interest you pay on this is a staggering £5,840 which is greater than the initial amount owed.

Putting this another way, that TV you bought on your credit card did not cost £1,000 as advertised in the shop.  If pay off the balance using the minimum monthly payment, it will end up costing you £2,168! What’s more you’ll probably be paying for it long after you have replaced it…

Obviously, the actual figures depend on your actual debt and the interest rate.  If you want to work out how much interest you will repay, check out our debt calculator.

What happens if you overpay on your debt?
We would recommend that you repay the most expensive debt you have (by interest rate) as quickly as you can afford to.   This will have the effect of greatly reducing the amount you repay in interest, and will probably take years off your debt repayments. You should check with your lender whether there are any penalties to overpay your debt, as some loans do this.

Let’s take the example above – you owe £5,000 on a credit card at 20%, with minimum payments of 2% or £100 per month. Set out below is the effect of making various overpayments:

• Pay the minimum payment
  £0 overpayment (£100 total) – 109 payments totalling £10,840
• Overpay by £10 per month
  £10 overpayment (£110 total) – 86 payments totalling £9,430, saving 23 months (nearly 2 years) and £1,410 interest.
• Overpay by £30 per month
  £30 overpayment (£130 total) – 62 payments totalling £8,057, saving 47 months (nearly 4 years) and £2,783 interest.
• Overpay by £50 per month
  £50 overpayment (£150 total) – 50 payments totalling £7,359, saving 59 months (nearly 5 years) and £3,481 interest.
• Overpay by £100 per month
  £100 overpayment (£200 total) – 33 payments totalling £6,522, saving 76 months (over 6 years) and £4,318 interest.

Don’t make the expensive mistake of just paying the minimum on your debts.  Take control of your finances and start getting your money working for you.  Check out our free debt calculator on our website.

With the UK election due on the 6th of May, we thought it might be useful to look at the policies of the main 3 political parties.

Tax

Comments
It is obvious that after the election that taxes need to rise, or services need to be cut (or both), to combat the heavy borrowing taken by the State during the credit crunch.  We would expect more measures to be announced after the election.

Financial products

Comments
Employers won’t be happy about the proposed changes to company pensions, but we do think this is a good thing. Anything which encourages people to start saving towards their retirement will go some way to solving our demographic time bomb.

The commitment to increase pensions in line with average earnings is a welcome change, although this does not make up for the many years where state pensions fell behind average incomes.

We are generally not in favour of replacing the FSA (with the Bank of England or anyone else). This is not because of any particular view other than we are not convinced that this change would make any difference to consumers.  Actually, most of the same people would probably run the new regulator, and all this would achieve is more cost to us as a business, and therefore to our clients.

For more information see:

http://www.labour.org.uk/policies/home

http://www.libdems.org.uk/pocket_guide_to_policy.aspx

http://www.conservatives.com/Policy.aspx

Here is our summary of today’s budget.  This is not designed as a comprehensive list of the areas covered, but rather a commentary on the financial implications.

Stamp Duty
Stamp duty below £250,000 has been abolished for 1st time buyers from midnight tonight. 90% of first time buyers won’t pay stamp duty. This applies for this tax year and next tax year only.

But for properties over a £1million, stamp duty will rise to 5% (from 4%). Mind you, that’s a whopping £50,000 tax on such a property purchase!

Entrepreneurs relief
Good news if you own a business – entrepreneurs relief has been doubled to £2 million.  This means that you only pay 10% tax on the profits from the sale of your business, rather than 18%.

ISAs
As previously announced, maximum allowable tax-free ISA contributions are to be £10,200 from April (for everyone).  These limits will increase by inflation each year in future.

Income tax, national insurance, VAT, capital gains tax
No changes not already announced.  Obviously, the 50% tax on earnings over £150,000 has already been announced.

Tax relief on pensions
Confirmation of previously announced restrictions on tax relief on pensions, which affect top earners.  See here.

Public sector pensions
Reforms will be made to cut the pensions bill, which sounds ominous if you work for the state…

Freezing of inheritance tax thresholds
For a further 4 years, which effectively means a slight tax increase as assets (hopefully) increase in value.

Mortgages
HMRC is to open discussions with mortgage lenders on the formal introduction of an income verification service.  We are unsure how this would work in practice as this data is out of date by its nature for the self-employed by at least 9 months.

Fuel duty rises
Next month’s planned 3p increase in fuel duty will be staged to soften the blow. It will go up by 1p in April, another 1p in October and a final 1p in January 2011.

Bank bonuses
An extra tax on bank bonuses has already been announced.  The 50% extra tax has raised £2 billion (twice as much as predicted).

Tax evasion
The Government will be harsher on those caught evading tax offshore. They expect to raise up to £500 million per year.  Those caught will be fined up to 200% of the tax evaded.

Housing benefit
To be cut back for expensive properties.

Basic bank accounts
Everyone will be guaranteed access to a bank account – surely a necessity of modern life?

We often come across financial services firms which call their advisers “Financial Planners”.  They might call themselves Financial Planners, but what most of them offer is financial product sales.  The purpose of this post is to give you an idea of what we do as Financial Planners, compared to other Independent Financial Advisers, who might work for a firm or a bank.

We do this because we feel that the role of a Financial Planner is actually distinct from that of the rest of the financial services profession.  By consequence, we believe that it is very difficult for you to determine the differences between the various services on offer – we would prefer for the role of a Financial Planner to be enshrined and protected, just like that of a Chartered Accountant or Solicitor.

Much of this information is cribbed from the Institute of Financial Planning website, which is aimed at promoting the Certified Financial Planner qualification and standards (to which we subscribe).

What is Financial Planning?
Financial Planning is the process of developing strategies to help you manage your financial affairs so you can build wealth, enjoy life and achieve financial security. Financial Planning is an effective way of ensuring you are fulfilling your life ambitions without having to worry about your finances.  Financial planning is about building towards financial independence, and is not focused on goals, income, assets, expenditure etc.  This process is not about product sales (although obviously, products would be used towards the end of the process to achieve the goals set).  Financial Planners tend to be fee-based because they charge for the creation and maintenance of a plan rather than selling a product.  This means you get what you pay for – advice rather than sales.

What is Financial Advice
Financial advice is what is supplied by the overwhelming majority of UK financial advisers.  This tends to be bespoke, targeted, transactional advice leading to a financial product sale.  As most financial advisers are commission based, they rely on selling you a product to get paid for their work.

1. What is their experience?
   Obviously, this is important; but as important is to ask their experience in dealing with situations similar to those faced by you.
2. What are their qualifications?
   This is more important than many financial advisers will lead you to believe.  Having advanced and specific qualifications shows a technical expertise, and a commitment to keeping up to date with the current trends.  After all, would you go to a doctor who only had a basic level of qualifications, and hadn’t kept up to date in 20 years?
3. What services do they offer?
   They should be able to easily define the services they offer to clients so you can decide if these are right for you.  You need to decide whether a comprehensive ongoing review is right for you, or you just want transactional advice on a one-off basis.
4. What is their advice process?
   How they go about delivering their service is also important – after all, you want to ensure that you will get a robust and consistent delivery of your service.  Our advice is to avoid advisers who cannot easily articulate their process.
5. How are they paid?
   This is important to your pocket, but also to know if you need to watch out for signs of bias.  You also need to know up-front the extent of your liabilities.  Our preference is for a fixed fee agreement, but many people prefer to operate on commission.
6. What is the typical cost of their services?
   This will help you to decide if the service is affordable and fits in with your expectations.  Ultimately, you want to avoid an open-ended commitment on your side.
7. Who else benefits from their recommendations?
   This is a question often missed.  You may have been referred to the adviser following a recommendation.  Does the introducer receive any payment from this arrangement?  We are aware of some local independent financial advisers who regularly pay out up to 50% of their income to professional introducers such as accountants.  While this is fine if the client agrees, we would be concerned that the client is not aware of the arrangement.  If you think about it, if the introducer receives payment (of such a large amount), your adviser will be forced to increase the fees or commission charged to you to achieve their profit margins.
8. Have they ever been disciplined by the Regulator?
   You would probably want to avoid advisers who have been sanctioned by their professional body, but you can actually check this out yourself by searching for the firm or adviser on the FSA Register.  All financial advisers must be on this register to be able to off you financial advice.  If they are not registered, then you are not covered (and the ‘adviser’ should be reported).

I took a call from a friend over the weekend looking for some free advice on buying a house.  He is in his 20s and is looking to buy his first home.  He has been with his partner to visit a local housing development.  What concerns me is the sharp tactics to which he is being exposed.

Now, obviously I wasn’t in the room with him, but it seems to me that there is a lot of sharp marketing going on here…

• They can afford the 2-bedroom option, but prefer the 3-bedroom house, which is probably slightly outside of their price band;
• They have a 10% deposit (just sufficient for a 1st time buyer);

They have now reserved a 3-bedroom house on the basis that ‘another couple’ are interested in it, and they have an offer on it, which will only be available for that weekend.  This sounds unlikely to me given that there are numerous developments, with a limited number of buyers in the current market.  They are being offered an incentive of an interest-free 15% loan, which is repayable in 10 years – on the basis that the house will go up in value over that period.  What’s more, they must use the developer’s pet mortgage broker to be eligible for that deal.

I tried to tell him that my theory is that all new builds are 30% more expensive to start with, to give them the room to negotiate on price, or to offer ‘incentives’ like this.  However, the buyer is more concerned with securing the dream house rather than the intricacies of their financial future.  The mortgage broker offered them a perfectly decent loan, but over a term of 35 years to make the monthly payments affordable.

My concerns:

• Why encourage them to buy a house that is stretching their budget if to do so they must pay over 35 years?
• Why should they be forced to use a broker they don’t want?
• What happens if something goes wrong?
  • To the housing market (the estate agent said their house will be worth more in 10 years time, so they can just remortgage to take on their extra debt)
  • To their income – their circumstances might dictate that the mortgage becomes unaffordable or they might not be able to afford to pay back the extra 15%
  • To their personal situation – what happens if they break up, have kids or want to move?  They still owe the 15% incentive

If you are reading this blog you are no doubt interested in financial planning and what it can do for your future financial prosperity.

Have you ever wanted to prepare your own comprehensive financial plan, to work towards your future financial independence without having to pay for it?

Well now you can!  We have just launched Your Financial Plan - this is a free resource designed to give you all the tools you could need to be able to prepare your own comprehensive financial plan.

Take a look, and if you like what you see, sign up to receive the free materials.  You can unsubscribe at any time.