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Understanding Interest Rates

Understanding Interest Rates

In the UK, interest rates have now been so low for so long that even those who are, technically, old enough to remember the double-digit inflation of the 1980s, may have forgotten what it meant in practice.  It meant that cash deposits could bring could returns for savers – but borrowing could be eye-wateringly expensive.  With Brexit on the horizon and a “no-deal” looking close to certain, now may be a good time to go over interest rates, the theory and practice.

When currencies weaken, interest rates tend to go up

The Monetary Policy Committee of the Bank of England is tasked with keeping inflation at exactly 2%, but since this is the real world, it is allowed a 1% “margin of error” either way.  If inflation falls below 1% or rises above 3%, however, the Bank of England has to write an open letter to the chancellor explaining what it intends to do about it.  If inflation falls below 1%, the BoE has two options.  It can lower interest rates (assuming there is room for it to do so) or it can implement a programme of quantitative easing.  When inflation goes up, however, the BoE’s only option is to increase interest rates.

The Brexit question

If Sterling weakens due to Brexit (or for any other reason), it will increase the cost of importing goods from overseas.  If this cost is offset by gains elsewhere, such as inbound tourism, then the net effect may be zero (or close to it), but if it is not, then either the UK will have to cease (or severely limit) its imports and/or inflation will increase and in the latter case the BoE will be forced to raise interest rates to meet its 2% target.

The only other option would be for the government to change the inflation target in some way, either by permitting inflation to go higher or by changing the means by which it is measured (such as the change from the Retail Price Index to the Consumer Price Index).  This is certainly possible, but it would be politically challenging.  Allowing inflation to rise would potentially impact everyone, including borrowers, whereas allowing interest rates to rise would benefit savers but hurt borrowers. Raising interest rates would also, at least potentially, make Sterling more attractive on the international markets, thus potentially bringing the value of the currency back up and lowering inflation naturally.  Having said that, this tactic did not work for John Major back in 1992, when the UK exited the ERM.

What this means in practice

In very blunt terms, Brexit could mean that savers finally get to see better returns on their cash deposits and borrowers start to see an increase in the cost of financing their debt.  Having said that, it is still very possible that savers will not see enough of a benefit to make it worth their while to readjust their asset allocation in favour of cash.  Borrowers, by contrast, will have no option but to swallow up the higher interest rates as they will be reflected across all lenders albeit to varying degrees.  This means that it is now critically important for borrowers to do everything in their means to pay down debt as quickly as possible and the higher the level of interest payable on the debt, the more important it becomes to pay it down.  If borrowers are unable to pay down their debt immediately, for example, if they have mortgages with long terms, then it may be worthwhile to switch to a fixed-rate product so at least they will have the security of knowing what their payments will be over the life of the product.  As always, however, individuals will need to do their own sums to see if this approach makes sense in their own situation.

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How to insure against the winter blues

How to insure against the winter blues

Summer, such as it was, is now very definitely over and autumn is starting to make itself felt.  Depending on your point of view, we’re now either coming into the season of hot chocolate and hygge or coming into the season of cold, wet weather and general misery.  Even if you love the cooler months, the fact still remains that they do bring their own challenges, but the good news is that you can protect yourself against them by “self-insuring” (following good practices) and taking out formal insurance cover.

Insuring your health

Even though minor illnesses and injuries and frankly part and parcel of autumn and winter seasons, you don’t just have to cave into them.  Just being sensible about what you eat and drink can go a long way to boosting your immunity and if you make time for exercise as well, especially outdoor exercise, then you will put your body in a much better place to ward off the cold-weather nasties.

At the same time, however, you have to be realistic about what life can bring and about what you can do to be prepared for it.  With that in mind, it could be a good idea to take out dental insurance, if not full medical insurance.  Autumn rains and leaves and winter ice are all serious tripping hazards, which can easily leave you with damaged teeth – and dental bills can be very expensive.  Thanks to the NHS other forms of treatment are often much more reasonably priced, in fact, they may be free, but there may be a lengthy wait for them and the treatments on offer may not be as extensive as you might have liked (e.g. they might not include physiotherapy after an accident or may only offer limited sessions).  This is why full health insurance can be a great investment.

Insuring your income

For most people, their income is dependent on their ability to get to work.  If your ability to get to work depends on you having your own transport of some sort, then it’s a good idea to give your vehicle a thorough check and take any necessary action before the cold really sets in.  You may also need to think about whether you should take any other precautions related to travel in cold weather, such as upgrading your insurance to include accidents and perhaps even a call-out service.

You may also want to think about what would happen if a long-term illness or injury left you unable to work for any length of time (or to function as a parent, a carer or in any other capacity).  Depending on your stage in life, you may be able to get by with a basic emergency fund, but if you have people depending on you in any way, such as for childcare, then you may want to look seriously at Critical Illness Cover for protection during long-term illness.

Insuring your property (and its contents)

Most people will probably already have insurance for their home and contents, however, you can reduce the chance of needing to make a claim on your buildings insurance by making sure that you have done everything possible to ensure that it can withstand everything the weather is going to throw at it.  Now is also a good time of year to review your contents cover to ensure that it is still an accurate reflection of what is inside your home and to think about any potential large purchases you may want to make, either at Christmas or in the January sales.

For motor insurance, mortgage payment protection insurance, building and content insurance and general insurance products we act as introducers only.

 

How applying for a mortgage is like applying for a job

How applying for a mortgage is like applying for a job

These days, you don’t necessarily have to go to an interview to get a mortgage the way you usually do to get a job, but other than that the processes are, perhaps surprisingly, very similar.  In a recruitment scenario, the recruiter is essentially asking themselves three basic questions:

  • Can you do the job?
  • Will you do the job?
  • Will you fit in?

This is also what mortgage lenders want to know, so your mortgage application should aim to convince them that in your case the answer to all three questions is a solid yes.

Cover your basics, fill in the application the way you are asked

Employers have long used various tricks to work out which job seekers actually read adverts and follow instructions and which do not.  One of those tricks is to specify how an application is to be submitted.  In the old days it was often colour of ink (black not blue), these days it can be to include a particular word in your cover letter.  Mortgage lenders aren’t usually looking to weed out candidates who can’t follow instructions, but they are likely to be using computer systems to process part, if not all, of an application and hence they may specify how data is to be entered into each field.  If they do, make sure you follow the instructions.  Also, make sure that any data you enter does completely answer the question, otherwise the best you can hope for is that a potential lender requests further information.  They may, however, just decline you because you come across as unsuitable.

Can you do the job?

Remember that these days mortgage lenders are obliged to look beyond your headline income figures and think about your likely ability to repay a mortgage over the long term.  This means you want to do anything and everything you can to convince them that you will be able to bring in an income over the lifetime of your mortgage.  For example, if you had plans to upskill yourself and/or to start a side hustle with a view to bringing in extra money (at some point if not immediately), then it would be a great idea to set the ball rolling before you even applied for your mortgage.

Will you do the job?

A mortgage lender is going to look for evidence of how well (or badly) you have managed your money in the past, which means that they’re going to take a close look at your credit record.  Do everything you can to make this look impressive.  If you’ve had a chequered financial history, time may be your friend.  Negative markers such as late payments drop off after a certain time.  If you know you have them, you might want to check when that time is and see if you can hold off applying for a mortgage until after it is past.  Once it is past, make sure it is removed correctly.  Even if you have a perfect financial history, it’s still a good idea to check your credit record for mistakes (they happen) or to see if you can make any small touch-ups which could help you (like making sure you’re on the electoral register).

Will you fit in?

Does your application fall within the lender’s “comfort zone”?  In blunt terms, a lender needs to think about how easy it would be to recoup their money in the event of a foreclosure.  Standard, residential properties in popular locations tend to be relatively easy to sell on.  Niche properties and properties in more out-of-the-way locations can be rather more of a challenge to sell.  Similarly, buyers actually living in the properties, or at least in the UK, are easy to trace, whereas expat buyers may be perceived as rather more of a risk.

 

Your property may be repossessed if you do not keep up repayments on your mortgage.

 

The truth about the landlord loophole

The truth about the landlord loophole

It’s probably fair to say that the government is not exactly popular with property investors at this point in time.  While it’s understandable that they may wish to prioritise residential buyers in general (and first-time buyers in particular), the ideal way to do this is to work to smooth the path to property ownership (and indeed moving home) rather than to keep creating obstacles for landlords, especially when the UK has such high demand for rental property.  Be that as it may, change is a constant in life and people just have to deal with it.  One way some property investors have opted to deal with the current round of changes is to move their property portfolio from a private holding to an asset held by a limited company.  This move has been widely publicised as the “landlord loophole”, but, as is often the case, the situation is rather more complex than some media articles make it appear.

It is illegal to try to use a limited company structure purely to avoid tax

Please take careful note of that previous sentence.  If you move your property portfolio into a limited company purely to avoid tax you will be breaking the law and if you are caught (which is entirely possible, if not highly probable), then the best result you can hope for is that you wind up paying HMRC the tax you would have been due in the first place, plus you will have to write off the (far from inconsiderable costs) of setting up a limited company.  A worst-case scenario is that you spend a lot of money on lawyers only to end up being convicted of tax fraud, an offence which can land you in prison (albeit typically only in the very worst cases).

Using a limited company structure the wrong way can see landlords paying more tax

Private individuals pay income tax on all income, including any rental income from property held in their own name.  Limited companies pay corporation tax on all profits generated by the company.  When company profits are handed over to third parties, they become subject to some form of taxation, the exact form of which will depend on the way in which the money is disbursed.  The likeliest options are dividend tax and income tax.  If your income from other sources is minimal, and you depend on the income from your rental property to pay your bills then switching to a limited-company structure could be an expensive mistake as the double-taxation effect might lead to higher tax bills, if not now than in the future.  By contrast, if you are a higher earner and are currently in a position where you can afford to live without the rental income from your property portfolio, then switching to a limited-company structure may reduce the level of tax you pay.  In short, if the profits from a company are held within a company, they will only be subject to corporation tax, which is likely to be much less than the income tax higher earners would have paid.  Then if/when your income drops (e.g. you retire), you can start to withdraw income in a controlled (and tax-sensitive manner).

Limited companies can be useful for estate planning

On the subject of retirement, limited companies can be useful from the point of view of estate planning especially for property investors, since they provide a convenient way to apportion the benefits of your estate.  For example, if you currently own two properties and bequeath one to each of your children, circumstances may conspire to deal one of them a much better hand than the other, whereas if both properties are held in a limited company which is bequeathed to your children in equal shares, then they benefit from it equally.

 

Your property may be repossessed if you do not keep up repayments on your mortgage.

The FCA does not regulate some forms of estate planning. For these services we act as introducer only.

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