r01/2.2: Financial Planning: Budgeting, Debt Management, and Mortgages

Importance of Budgeting

It helps clients control their finances, ensuring they can pay monthly outgoings and cover large one-off expenses.

What two main factors should be considered in a client's financial assessment? Why is this important?

Income details and main outgoings. Drawing up a detailed breakdown of their expenditure.

It shows Whether the client is living beyond their means or has surplus income available for financial planning.

Why is it important for clients living off investment income to budget?

Dipping into the investment reduces its ability to produce required income.

What does the difference between income and expenditure represent? What is a potential issue with this?

The client's disposable income. It may lead to exaggerated expectations about how much the client can afford to save.

How can clients redirect their income for better financial planning?

By reducing spending in lower priority areas, like eating out, to fund higher priority expenses, such as insurance premiums.

Why is it important to fully understand a client's income and expenditure position? What is its role?

To formulate sustainable recommendations that balance needs and budget.
It helps obtain client agreement to proceed with recommendations.

What can happen if assumptions are made instead of a full analysis?

Clients may struggle to maintain financial commitments, leading to policy lapses and loss of value.

What is the first step in managing debt? What is a better approach than recommending a perfect solution that clients cannot afford?

Working out how much money is coming in and going out.

Recommending a partial solution that clients can sustain.

What types of income should be included in a client's financial assessment?

Earnings from employment, benefits, pensions, savings, investments, and other income sources.

What are the three headings under which expenditure can be categorized?

Essential spending, everyday spending, and occasional or non-essential spending.

What should clients do if they are struggling to make ends meet?

Reduce their spending. Make small cut-backs on non-essential items.

What does the annual percentage rate (APR) indicate?

The overall cost of borrowing, including interest and charges.

What should clients do before switching services like phones or utilities? Why should clients shop around?

Clients should draw up a list of people and companies they owe money to and prioritize their debts. To potentially lower the overall cost of borrowing.

What are considered priority debts?

Priority debts include mortgages, utilities, and council tax.

What are examples of debts of lesser importance?

Debts of lesser importance include credit cards, overdrafts, and personal borrowing.

What signs indicate that a client may have a debt problem?

Signs include using credit to pay everyday bills, considering consolidation loans, paying only minimum amounts on credit cards, taking cash advances, or borrowing without a repayment plan.

What is a Debt Management Plan (DMP)?

Clients should contact their creditors as soon as possible to discuss payment arrangements. A DMP is a plan set up by a third-party provider to consolidate debts into one monthly payment, which is then distributed among creditors.

Who typically sets up a Debt Management Plan? What must DMP providers be licensed under?

Debt Management Plans are usually set up by debt charities or debt management companies. DMP providers must be licensed under the Consumer Credit Acts 1974/2006 and authorized by the Financial Conduct Authority.

What is debt consolidation?

Debt consolidation involves negotiating a new loan to repay existing loans, often with lower interest rates and monthly payments.

What caution should advisers take when recommending debt consolidation? What could happen if a client defaults?

Advisers should be cautious due to potential high fees, the risk of paying more over time, and the possibility of clients continuing to accrue debt. If the loan is secured on their property, the client could lose their home.

What should clients consider before using companies that charge fees for debt management services?

Clients should consider all other options and ensure they are aware of the fees involved.

What organizations offer free debt management services? What can these advice agencies help clients with?

Organizations like Citizens Advice, National Debtline, PayPlan, and StepChange Debt Charity offer free services.

They can help clients set up a budget, prioritize debts, and learn to live within their means.

What are the last options available for clients facing severe debt issues? What should individuals in significant debt consider?

The last options are an individual voluntary arrangement or bankruptcy, both involving formal legal proceedings. they could benefit from debt counselling, possibly through services like Citizens Advice.

What might clients need to borrow money for?

Clients may wish to raise funds for home improvements, starting a business, or paying for personal events like holidays or weddings.

What is the main risk associated with loans secured on property? What is the common misconception about the term 'mortgage'?

Clients could lose their home if they fail to make the required repayments. Most people refer to a mortgage as a loan used to buy a property, but it is actually the security offered in exchange for the loan.

What is the process called when the security is signed over to the lender?

The transfer of ownership is called the assignment.

What is typically offered as security in a property loan? Why do most lenders no longer take actual deeds for property loans?

The deeds of the property. Due to the cost and risk of storage; they usually register a charge on the property with the Land Registry instead.

What are the two main methods of mortgage repayment?

Capital and interest repayment, and interest-only repayment.

How does capital and interest repayment work?

Monthly repayments include a contribution towards the capital and interest, gradually repaying the loan over time.

What happens to the interest and capital portions of the repayment over time in a capital and interest mortgage?

The interest portion decreases while the capital portion increases.

What is an interest-only mortgage? What are the potential downsides of an interest-only mortgage?

Only the interest on the loan is repaid during the term, with the capital remaining the same.

Without a repayment plan, it is not suitable in the long term as there is no method to repay the capital borrowed.

What is the intended method of repaying an interest-only mortgage at the end of the term?

From another source such as an endowment policy, ISA, or by selling the property.

What led to the popularity of interest-only mortgages in the 1980s?

Rising house prices made capital and interest repayment mortgages unaffordable for many buyers.

What caused a revival in the use of capital and interest repayment mortgages after the financial crisis?

Issues with alleged endowment mis-selling and the need to guarantee repayment of mortgages.

What is the Mortgage Market Review (MMR)?

A regulation that came into effect in April 2014, reducing the availability of interest-only mortgages and requiring lenders to check borrowers' repayment strategies.

What is the role of Citizens Advice in the context of debt?

They provide debt counselling services to individuals in significant debt.

What is a 'buy to let' property investment?

A property purchased with the intention of renting it out to tenants.

What should clients with significant cash or investments consider regarding their mortgages?

They should consider using these resources to reduce their borrowings.

What is a temporary assignment in the context of mortgages?

The transfer of ownership of the security (property) to the lender for the term of the loan.

What is the impact of interest rate changes on monthly repayments for mortgages?

Monthly repayments usually only change if interest rates change and the client does not have a fixed rate deal.

What was a common mortgage type before the 1980s?

Most mortgages were capital and interest repayment.

What is a potential benefit of an interest-only mortgage in the short term?

It is cheaper than a capital and interest repayment loan.

What is a cap and collar mortgage?

A mortgage where the lender guarantees that the interest rate will not rise above a certain level (the cap) or fall below a minimum rate (the collar), ensuring rates stay within a specified range for a given period.

What is a capped mortgage?

A mortgage where the lender guarantees that the interest rate will not exceed a specified level for a certain period.

What is a discount mortgage?

A mortgage where the interest rate is reduced by a set percentage below the standard rate for an initial period, typically one to three years.

What is a Euro mortgage?

A mortgage where the interest and capital are designated in euros or another foreign currency, potentially benefiting from lower interest rates.

What are equity-linked mortgages?

Also known as shared appreciation mortgages (SAMs), these involve the lender taking a stake in the property's equity, with the borrower repaying the lender's equity stake upon sale of the property.

What is a fixed interest mortgage?

A mortgage with a fixed interest rate for a specified period, providing predictable payments but risking higher costs if market rates fall.

What is a flexible mortgage?

A mortgage that allows varied monthly payments and lump-sum repayments, creating a reserve that borrowers can withdraw from if needed.

What is a green mortgage?

A mortgage that offers favorable terms for purchasing energy-efficient homes, such as lower interest rates or cash back, often limited to new builds.

What is an offset mortgage?

A mortgage linked to a current account, where interest is charged on the net balance of both accounts, potentially reducing overall interest payments.

What is a tracker mortgage?

A variable rate mortgage that automatically adjusts to track an index, typically the Bank of England base rate.

What is equity release?

A range of products available to older clients (typically over 60) that allows them to release cash tied up in their home without a fixed term.

What are the two main types of equity release schemes?

Lifetime mortgages and home reversion plans.

What is a lifetime mortgage?

A loan secured on the home that allows the client to stay in their home for life or until moving into long-term care.

What is a roll-up mortgage?

A type of lifetime mortgage where interest is added to the loan balance, increasing the total owed over time.

What is a lump sum mortgage and how is it repaid?

The client receives a lump sum or regular income, charged monthly or yearly interest added to the loan, and repays the original amount plus rolled-up interest when the home is sold.

What is a fixed repayment lifetime mortgage?

The client receives a lump sum but pays no interest; instead, they repay a higher agreed amount when the home is sold.

How does an interest-only mortgage work?

The client receives a lump sum and pays monthly interest on the loan, with the original amount repaid when the home is sold.

What is a home income plan?

The money borrowed is used to buy a fixed income for life (an annuity), which pays the interest on the mortgage, with the original amount repaid when the home is sold.

What is a shared appreciation element in lifetime mortgages?

Historically, some lifetime mortgages allowed the lender to share in the value of the home.

What is a drawdown facility in lifetime mortgages?

It allows clients to borrow small amounts as needed rather than one large loan, reducing interest costs.

What happens to the home when the client dies or moves into long-term care?

The home is sold, and the sale proceeds are used to pay off the loan; any remaining funds go to the client or beneficiaries.

What is the no negative equity guarantee in lifetime mortgages?

It ensures that clients or their beneficiaries will never owe more than the home's value, even if the debt exceeds it.

What is a home reversion plan?

The client sells all or part of their home for a cash lump sum or regular income, retaining the right to live in it until death or long-term care.

How much of the market value can clients expect to receive in a home reversion plan?

Clients typically receive between 20% and 60% of the market value, with older clients receiving a higher percentage.

What are the two types of Sharia-compliant home purchase plans?

Ijara, where payments are held to buy the home at the end, and Diminishing musharaka, where payments increase the client's share while reducing the firm's share.

What are sale and rent back agreements?

These agreements allow companies to buy a client's home and rent it back to them for a fixed period, often referred to as mortgage rescue or rent back schemes.

What is the purpose of B4B home purchase plans?

They help clients buy a home without paying interest, particularly for Muslims seeking compliance with Sharia law.

What is the typical time frame for sale and rent back agreements to be completed?

These transactions can be completed quickly, sometimes within a week, but more commonly within three to four weeks.

What must firms ensure when selling sale and rent back schemes?

Firms must treat clients fairly and ensure their advertising is clear, fair, and not misleading.

What is the role of the home reversion provider in a home reversion plan?

The provider owns the home or part of it after the sale, allowing the client to live in it under a lease.

What is the significance of the lease terms in a home reversion plan?

The lease terms can vary, including nominal rent options or higher rent for more money from the sale.

What happens if the sale of the home does not cover the loan amount?

The client or their beneficiaries must repay any amount exceeding the home's value.

What is the benefit of a drawdown facility compared to a lump sum mortgage?

It is cheaper as clients only pay interest on the amount they actually withdraw.

What is the main difference between a fixed repayment lifetime mortgage and a roll-up scheme?

In a fixed repayment lifetime mortgage, the client does not pay interest, while in a roll-up scheme, interest is added to the loan.

What is the impact of age on the percentage received in a home reversion plan?

Older clients typically receive a higher percentage of their home's market value.

What is the primary concern for clients when considering lifetime mortgages?

Clients should be aware of the potential for the debt to exceed the home's value and the implications of repayment.

What are the potential risks for clients selling their home through regulated firms?

Clients may be paid less than full market value, have limited time to stay in their home, risk eviction for breaching tenancy terms, and face repossession if the buying firm encounters financial difficulties.

What is the primary purpose of a buy-to-let mortgage?

To generate income from rents and achieve capital gain upon selling the property.

What distinguishes consumer buy-to-let mortgages from business buy-to-let mortgages?

Consumer buy-to-let mortgages are regulated by the FCA and are for borrowers not primarily engaging in business, while business buy-to-let mortgages are not regulated and are for professional landlords.

What is an example of a situation that qualifies for a consumer buy-to-let mortgage?

Borrowers needing to let out their home while traveling overseas or those who inherited a mortgaged property.

Why are business buy-to-let mortgages not regulated by the FCA?

Because borrowers are considered professional landlords engaging in an enterprise, not consumers needing protection.

What are the two main types of loans?

Unstructured loans and structured loans.

What are unstructured loans and what are their characteristics?

Unstructured loans include mortgages and commercial property loans, allowing for increased repayments, no penalties for early repayment, and interest rates that vary based on default risk.

What types of loans fall under the category of unstructured loans?

Mortgages, loans on commercial property, overdrafts, and some personal loans.

What defines structured loans and their repayment structure?

Structured loans are used for smaller purchases, have fixed interest rates and repayment structures, and payments do not change with base rate fluctuations.

What is a disadvantage of structured loans?

They often come with higher costs and penalties for early repayment.

How does the interest rate on unstructured loans relate to risk?

The interest rate varies based on the perceived risk of default, typically linked to a base rate.

What is the implication of a 1% interest rate above the base rate?

It indicates a good risk assessment by the lender.

What does a 4% interest rate above the base rate suggest?

It implies a higher than average risk of default as assessed by the lender.

What is a common feature of structured loans regarding interest rates?

They have a fixed rate of interest that remains constant throughout the loan term.

What is one advantage of structured loans for borrowers?

They make budgeting easier due to fixed payments.

What is a potential downside of structured loans compared to unstructured loans?

They may have higher costs and penalties for early repayment.

What happens if a client breaches tenancy terms in a buy-to-let scenario?

The client could be evicted.

What can happen if the firm buying a home goes into financial difficulties?

The property could be repossessed, requiring the client to leave.

What is the risk associated with selling a home to a regulated firm?

Clients may lose ownership of their home despite being able to stay temporarily.

What is the role of the FCA in consumer buy-to-let mortgages?

The FCA regulates these mortgages to provide consumer protection.

What is the definition of a consumer buy-to-let mortgage?

A mortgage not entered into predominantly for business purposes by the borrower.

What is a common characteristic of borrowers considered 'accidental landlords'?

They require consumer protection due to their unintentional engagement in renting out property.