First-time buyers: the pros and cons to consider of high loan-to-value mortgages
Just what are high loan-to-value mortgages and how can they help first time buyers?
We have a housing shortage in the UK. Because of that shortage, even though the housing market has slowed down significantly in recent years, house prices continue to rise.
According to the most recent data from the Office for National Statistics, the average property today is worth £228,147. Go back five years and it was just £178,182.
This, of course, makes it all the harder for would-be buyers to build up healthy deposits to put down against a property. As a result, they may be faced with the limited choice of deals that are available if they have a 5% or 10% deposit to hand.
The good news for borrowers with small deposits
There is some good news on this front, in that the rates charged on these deals are becoming much cheaper. Back in February 2013, the typical interest rate on a 90% loan-to-value (LTV) two-year fixed rate mortgage stood at 4.8%, while for a 95% mortgage that rose to 5.43%.
Today those average rates have dropped to 2.65% and 3.30% respectively, even though the Bank of England has increased base rate since then.
It’s not just the rates on offer though - there are far more deals to choose from now, with Moneyfacts data confirming there are now 391 deals on the market for borrowers with a 5% deposit, compared to just three a decade ago. ()
The Help to Buy equity loan scheme
In a bid to give buyers with a small deposit a further boost, the government has also introduced the Help to Buy equity loan scheme.
While you stump up a 5% deposit, you also borrow a 20% equity loan from the government, which is fee-free for the first five years. That means you only need to get a 75% mortgage, meaning you benefit from much lower interest rates.
The problems that come with a small deposit
There are some concerns buyers need to bear in mind when using a high loan-to-value mortgage to purchase a property.
The first is that, even though rates have become more competitive as lenders have battled for business, you still face paying a much higher rate if you are borrowing with a 5% or 10% deposit than if you have 20% or more at your disposal.
For example, at the time of the writing the lowest interest rate on a two-year fixed rate mortgage for a buyer with a 20% deposit is 1.60% from NatWest. But this increases to 1.78% for a 10% deposit and 2.59% for a 5% deposit.
This means larger monthly repayments, or else going for a longer mortgage term - meaning it costs more overall - in order to reduce the size of those monthly bills.
Then there is the threat of negative equity. This is where your outstanding mortgage is greater than the value of the property. So, if you bought your home with the use of a 95% LTV mortgage and a year later house prices had fallen by 10%, you would likely be in negative equity.
This will make remortgaging to a new deal, once the initial fixed period has ended, very difficult, leaving you stuck on an expensive rate.
Similarly, it will make moving house quite challenging - the money you get for the property won’t pay off the existing loan, let alone provide a deposit for your next home.
Can I buy without a deposit?
If you don’t have tens of thousands of pounds sitting in your savings account, ready to use as a deposit, then don’t panic - there are still mortgages available which could help you take that first step onto the housing ladder.
It will require help from your parents though.
Generally, this means that you will borrow 90% of the value of the property. The remaining 10%, instead of coming from a deposit, is secured against either your parents’ savings or their property.
With the latter, an important thing to consider is that if you fall behind on your repayments, the lender can pursue your parents to repay the loan. In other words, it’s not just your property that is at risk of repossession - your parents’ home could be too.
Other forms of parental help
There are other schemes available to first-time buyers which involve help from parents, and can reduce the need to save a significant deposit.
A good example here is the First Start mortgage from Post Office, which involves you taking out a mortgage alongside a parent as ‘co-borrowers’. The idea is that as both incomes are included in the affordability calculations, you may be able to borrow more.
There is a big potential downside here though - if you opt to name a parent on the property deed who is already a property owner, then you will end up paying the additional Stamp Duty rate, which is charged on purchases of second homes.
It’s an extra 3%, which can make a massive difference - on a £200,000 home it could mean a bill of £7,500 rather than £1,500 for example.
Alternatively, you could use a family offset mortgage. The parents’ savings are ‘offset’ against the outstanding mortgage balance, meaning you only pay interest on the difference, which can help make repayments more affordable.
For example, let’s say you need to borrow £180,000, but your parents have £20,000 in savings. By linking the two through a family offset mortgage, you would only pay interest on £160,000 of that debt. However, your parents would sacrifice earning interest on their savings as a result.
John Fitzsimons is a freelance financial journalist who has been writing about money for more than a decade, appearing in the likes of the Sunday Times, the Mirror, the Sun and Forbes.