Build your skills for managing your money

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1 Choosing your mortgage Part 1 This task has three parts to it. Part 1 This is where you will find information and activities to help you understand your mortgage payments and feel more confident to make decisions when you make your mortgage choices. N1/L1.1, N2/L1.4 N2/L1.9 D(f) 4, D(e) 4 Part 2 Suggestions of other free resources to help you to practise your skills can be found here. Part 3 This is where you can try out your skills on some practical activities and check your progress on typical questions from the Level 1 National Test. Part 3 also contains the answers to all the activities in Parts 1 3. Thinking about paying your mortgage When we take out a mortgage, we are borrowing money to buy a house or other property. In order to be able to borrow the money, we agree to pay the mortgage company (the lender) interest on the money we ve borrowed. We pay them a regular amount in the form of a mortgage payment usually paid monthly. Until we have paid back all the money we owe to the lender, they have a financial interest in the property. This is recorded with the Land Registry. We ll look in more detail at how mortgage payments are made up in activities 3 5. Before that, we will look briefly at two skills particularly useful in this context: handling large numbers; and dividing by 10 or 100 to help work out percentages. If you feel you are confident with these skills already, you may want to read the examples and then move straight on to the next activity without actually doing the task. 1 Numeracy at Level 1

2 Thinking about working confidently with large numbers We don t often come across numbers as big as multiples of thousands and therefore we can sometimes lack confidence when dealing with numbers of the size involved when buying a house or other property. There are two aspects to this: first, we need to read and interpret large numbers; second, and probably more importantly, we can sometimes be unsure when calculating with them. Activity 1 looks at reading and interpreting large numbers. Activity 2 looks at calculating large numbers. In numbers, the individual numbers are each called a digit. So, for example, is a 6-digit number. To make reading and interpreting numbers easier to manage, we typically group digits together in small groups. Think about remembering or reading out a phone number and notice how you group the individual digits into groups of two or three. When we write large numbers, we also group the digits. Usually, we group them into threes. This is to make the number easier to read and interpret, because it helps us to recognise quickly the place value of each digit, e.g. to know where the thousands start etc. Example: Thinking about numbers in the thousands: Looking at the number starting from the right-hand side, the thousands appear after the first group of three digits Two hundred and forty-seven thousand 2 Numeracy at Level 1

3 Example: Thinking about millions (if we get that large!): Looking at the number starting again from the right, the millions appear after the second group of three digits Two million, four hundred and seventy thousand Sometimes house prices are written like this: 250k. The k stands for kilo and means thousands. So this number would read as: Two hundred and fifty thousand Activity 1 Fill in the prices of these properties in words. The first one in each section has been done for you as an example. Cost in figures Cost in words Seventy-five thousand pounds Cost in figures Cost in words 7 220k Two hundred and twenty thousand 8 185k 9 179k 10 64k million 3 Numeracy at Level 1

4 Thinking about using place the value of digits to divide by 10 and 100 We can sometimes be unsure when calculating with large numbers, just because we are less familiar with them. Calculations we need to make with large numbers use the same methods as we usually use with small numbers. We need to keep track of the place value of the numbers involved. (So we can get the size of the answer correct, rather than it being 10 times too big or small!) Where a digit appears in a number tells you important information about the size of the number. Let s think about the number as an example: We need to put the digit 4 in the position below, to make it show four thousand. Thousands Hundreds Tens Units Th H T U The zeros are there to show which column the digit 4 belongs in, and so make it If we put the same digit in a different position, it will show a completely different amount, e.g. for forty, the digit 4 would go in this position: Thousands Hundreds Tens Units Th H T U. 4 0 Moving a digit one column to the left makes it 10 larger for each column it moves. On the other hand, for each column it moves to the right, it gets 10 smaller. We can use this to help us (multiply and) divide by 10 and 100 easily. This can be very useful when we are working out percentages. 4 Numeracy at Level 1

5 Key fact 1 10% is the same as dividing by 10. We can use this to work out 10% of amounts whatever the size of the number. Example 10% of = Th H T U To make the number 10 smaller ( 10) move all the digits one place to the right So 10% of = We can then use 10% to also work out: 20% (twice as much as 10%) 30% (three times as much as 10%) 5% (half of 10%) Key fact 2 1% is the same as dividing by 100. We can use this to work out 1% (and other small percentage amounts). Example: 3% of % of = Th H T U To make the number 100 smaller ( 100) move all the digits two places to the right So, 1% of = And... 3% will be 3 as much = = You will find more information about percentages in Part 2. 5 Numeracy at Level 1

6 Activity 2: Working out percentages by dividing by 10 or 100 Example: 5% of % of = % is half of this = = Work out these percentages of the amounts shown. Use dividing by 10 (to work out 10%) or dividing by 100 (to work out 1%) to help you with these calculations. Use the examples above to help you if you wish. 1 1% of % of Tip: You ve already worked out 1% (in Question 1 above). How does 2% relate to this? 3 5% of Tip: Remember that you can use 10% and halve it to work out 5%. 4 1% of % of % of % of % of Numeracy at Level 1

7 Activity 3: Working out monthly interest payments Interest rates are usually expressed as a percentage. E.g. Interest rate: 5% p.a. This means that the interest you pay will be 5% of however much you borrow each year ( p.a. stands for per annum and means each year.) So, for every 100 you borrow, you will pay 5 in interest each year. Example: I borrow at 5% p.a. The amount of interest I will pay in a year will be: 10% of = % is half of this = = in a year If I want to work out how much this will be per month, I can divide by 12: months = 750 a month in interest. Work out how much interest per month you would pay for each of these. 1 Borrowing at 3% p.a. 2 Borrowing at 2% p.a. 3 Borrowing at 4% p.a. 4 Borrowing at 3% p.a. 5 Borrowing at 5% p.a. 7 Numeracy at Level 1

8 Thinking about what a property really costs When we take out a mortgage, we have to say over what period we want to borrow the money. This is usually a fairly long time, such as 20 or 25 years. This is known as the term of the mortgage. If you want to know how much the mortgage is going to cost you over its full term, you can work this out by multiplying the annual interest you pay by the number of years over which you will be paying it. Example: You have a mortgage with an interest rate of 4% over 20 years. You have borrowed The amount of interest you will pay in a year will be: 1% of = 500 4% is 4 this = = in a year If you want to work out how much this will be over the full term, you can multiply by 20: = in interest over the full term of 20 years As well as the interest, of course, you also still need to pay back the original you borrowed. This amount of the original debt that you owe is known as the capital. Buying a property worth at an interest rate of 4% will actually cost in all ( property price interest). In the National Certificate, you will not be able to use a calculator. However, in everyday life we frequently use one, especially when we are working out our finances. The focus of the rest of this task is on understanding mortgage calculations, rather than calculating sums manually. Where you see this calculator icon, please use a calculator to work out the calculations if you wish to. 8 Numeracy at Level 1

9 Activity 4: Working out interest payments over the term of a mortgage Work out how much interest these people will be paying over the full term of their mortgage. Use the example on the previous page to help you. 1 Ramon has a mortgage for over 20 years and is paying 4% interest per year. 2 Nuran borrows over 25 years and is paying interest at 3% p.a. 3 Malcolm and Sue buy a house for and take out a mortgage of over 20 years. They are paying interest at 4% p.a. 4 Candice and Vin take out a mortgage for over 25 years and are paying interest at 4% p.a. 5 Ray and Lucine buy a property for and take out a mortgage for of this over 25 years. They pay interest at 5%. Thinking about Interest only versus repayment mortgages We may have two choices of how we pay back a mortgage. We might be able to borrow the money either: by an interest only mortgage; or by a repayment mortgage. The difference between the two is that if we borrow the money interest only, we only pay the interest we owe on the loan each month. This means that when we get to the end of the term of the mortgage, we still owe all of the original amount we borrowed. We must have some way of paying off the original capital we borrowed. If, on the other hand, we borrow the money in the form of a repayment mortgage, the money we pay each month is made up of two parts: the interest we owe + an amount towards paying off the cost of the original loan. The second element of the monthly payment is known as the capital repayment. 9 Numeracy at Level 1

10 Example: Jane and Simon take out a repayment mortgage for at an interest rate of 4% p.a. They make monthly repayments of 509. The interest they owe is: 4% of = per year This works out as: = 280 a month They are actually paying a total of 509 per month. We can work out how much of this is going towards paying off the capital (the original loan of ): Payment made 509 Interest element Capital repayment 229 This is the amount of the capital they are paying off each month. You don t usually have a choice of the amount of capital repayment element you pay: the lender works this out so that you will have paid off all the original debt by the end of the term of the mortgage. Because of this, a repayment mortgage is often thought to be a safer option. This is because you know that at the end of the agreed term for the mortgage you will have paid off your full debt and the property will be yours (the mortgage company will no longer own part of it)! Thinking about the above example, at the end of the first year Jane and Simon will owe less than they originally borrowed: Capital repayment 229 per month This works out as: months = over a year So they now owe (of the original loan): Capital repayment This is the amount of the original capital they still owe. At the end of each year, they would receive a mortgage statement from the lender, which tells them what they paid, how much of this was interest and how much of the capital they still have to pay. 10 Numeracy at Level 1

11 Activity 5: Repayment mortgages Work out the capital repayment element of these monthly mortgage payments. The first one has been done for you as an example. 1 The Rahmans have a repayment mortgage of Their current interest rate is 4% and they make monthly payments of 436. How much capital repayment are they making each month? Remember, their monthly payment = interest payment + capital repayment. We need to work out the monthly interest payment due: 4% of = per year This works out as: = 240 a month Then work out how much of this is going towards paying off the capital: Monthly payment 436 Interest element Capital repayment 196 per month 2 Anna and Karen have a repayment mortgage for at an interest rate of 4% p.a. They make monthly payments of 582. How much capital repayment are they making each month? 3 The Goldsmiths have a repayment mortgage of Their current interest rate is 3% p.a. and they make monthly payments of 381. What is the capital repayment element of their monthly mortgage payment? 4 Steve and Mo have a repayment mortgage of at an interest rate of 5% p.a. They make monthly payments of 545. How much of this is capital repayment? 11 Numeracy at Level 1

12 5 Jo has a repayment mortgage of and makes monthly payments of 429. Her current interest rate is 3% p.a. How much of the original capital will she have paid off by the end of the first year? Tip: Work out the monthly capital repayment first, then calculate how much this will be over the whole year. Thinking about choosing a new mortgage: different types of interest rate There is a wide variety of mortgage products on the market. Some mortgages are offered at a fixed rate of interest. Example: 4% fixed rate for 5 years. This means that you know how much interest you will pay for an agreed period of time. With this particular deal, the rate of interest is fixed at 4% for the first five years that you have the mortgage. 12 Numeracy at Level 1

13 The advantages and disadvantages of a fixed rate mortgage are: Possible advantages The interest you pay will be the same each month for the first five years. You know over this period exactly how much interest you will pay. If interest rates rise nationally over 4%, you would still pay 4% for the five years. Possible disadvantages You would need to pay an early repayment penalty if you want to change your mortgage before the five years is up. You are tied in to the mortgage for at least five years. If interest rates nationally drop to a lower percentage rate, you will still be paying 4%! Other mortgages are offered at a variable rate of interest. Example: 4% variable rate The interest rate on this type of mortgage goes up and down as the base rates (in the national economy) rise and fall. So, you pay different amounts of interest at different times, depending on what interest rates do. The advantages and disadvantages of a variable rate mortgage are: Possible advantages You get the benefit of any falls in interest rates. You know over this period exactly how much interest you will pay. Possible disadvantages You don t know how much interest you will be paying each month as this can vary. You are not tied to the mortgage (by penalty charges) for any length of time. If the interest rates go up, you could end up paying a lot more money in interest! These days, many variable rate mortgages on offer are tracker mortgages. For these the interest rate varies, but is directly related to the base rate. Example: Variable rate 3% (tracks base rate +2.5%) 13 Numeracy at Level 1

14 This means that if the base rate is 0.5% the rate at which you pay interest will be 3% at the start of your mortgage, but the rate will then vary as interest rates go up and down. The rate of interest you pay at any particular time will be 2.5% more than the current base rate. Note: These tracker mortgages are also often for a specific period of time (e.g. over 2 years), so may attract a penalty charge if you want to change mortgage before this time period is up. Thinking about choosing a mortgage: what deposit do you need? When you take out a mortgage to buy a property, you often can t borrow the total cost of the property, but must put in a minimum amount yourself towards the cost. This is a deposit against the cost of the property. In relation to information about the mortgage, this might be described in one of two ways: 1 Sometimes it is expressed as a simple percentage. Example: Minimum 20% deposit This means that if you want to buy a property costing , you will need to have 20% of (i.e ) to put down as a deposit. In effect, the mortgage company will only lend you of the money you need to buy the property ( ). 2 Sometimes the deposit is expressed as a loan to value rate (LTV). Example: Maximum LTV: 80% This means that the most you can borrow is 80% of the value of the property you want to buy. So if you want to buy a property costing , the maximum you can borrow would be 80% of this, i.e So, again the deposit you need would be ( ). 14 Numeracy at Level 1

15 A final thought: negative equity One of the things we have heard quite a lot about in recent years is negative equity. This is when your property is now worth less than the amount you borrowed to buy it, i.e. the capital you owe is more than the value of the property. This usually happens when the value of properties has dropped since you bought. Example: You bought a house costing two years ago and took out a mortgage of House prices have since dropped, and your house is now only worth You therefore have of negative equity. You borrowed and, of course, still have to pay back interest on this even though your property is no longer worth this amount! However, so long as you don t want to move house, this may not be a problem. Hopefully, when you took out the mortgage you had already worked out beforehand that you could afford to make the mortgage payments required. Unless your circumstances have changed since then, you will still be able to afford these payments, and the fact that you are in negative equity may not be an issue if the value of the property rises, as the value of the property will probably rise again. Now print out Part 2 of this task to find suggestions of other free resources you might want to use to practise these skills. 15 Numeracy at Level 1