Banks will begin offering mortgages to buyers with a deposit of just 5% this week, as the government-backed 95% mortgage scheme commences.
The scheme will allow both first-time buyers and current home owners to secure a mortgage with a 5% deposit, to buy a house for up to £600,000.
Mortgages with a 5% deposit existed before the pandemic, but lenders have been reluctant to dish our high loan to value (LTV) deals amidst the turbulent economy.
Under the scheme, the government will offer to take on some of the risk of low deposit loans, meaning lenders would have some protection from potential losses.
Clearly, the huge benefit of a 95% mortgage is that it makes homeownership a possibility for people who were previously unable to get on the property ladder.
This might appeal to you if you’re currently spending a lot on rent, are sick of dealing with landlords, or you’re currently living with family or in a flatmate situation that’s run its course.
But there are pitfalls to consider with a high loan to value mortgage. Here are a few things to bear in mind.
A 5% deposit does not guarantee a mortgage
As with any mortgage, you’ll still need to provide evidence that you can keep up with the monthly mortgage repayments if you’re hoping to buy a home through the scheme.
Banks ‘stress test’ your income, to see if you could afford loan repayments if interest rates rise. To check for yourself, Which? has an online mortgage interest calculator that enables you to see what your repayments may look like if the market changes.
“If you’re currently furloughed due to Covid-19, lenders will generally only take your furloughed income into account,” the site warns. “Some may be more flexible if you can provide a letter from your employer to say they’re paying you 100% of your salary or that you’ll be returning to work on a set date.”
It may not be the best value long term
The best interest rates and mortgage deals are (usually) reserved for the people with the biggest deposits.
“With only a 5% deposit you will be paying off the mortgage over a much longer period and interest rates could rise,” Jo Thornhill, finance expert at MoneySuperMarket tells HuffPost UK.
Interest rates also tend to be much higher if you’ve got less than 10% deposit, according to Money Saving Expert.
“If you can push for a 10% deposit then you’ll get access to a cheaper mortgage,” the site advises. “Mortgages typically become cheaper at 90%, 80%, 75% and 60% LTV. ”
House prices are really high right now
The combination of the stamp duty holiday and lockdown easing has created a flurry of movement on the property market, pushing up house prices. Therefore, you may be better off long term if you can wait for the market to settle and save up a larger deposit in the meantime.
The average asking price hit a new record high of £327,797 at the start of April, according to Rightmove, after jumping by £6,733 or 2.1% month on month. The high prices will mean a 5% deposit is still unaffordable for many people in some parts of the country. Zoopla has echoed this.
“Greater availability of 95% mortgages will have the greatest benefits for buyers in lower value housing markets in northern England and Scotland where a 95% mortgage is more attainable,” Richard Donnell, director of research and insight at Zoopla, says.
“The scheme will have less impact for buyers in southern England where high house prices are a major barrier to being able to afford a 95% mortgage.”
Be aware of negative equity
Negative equity is when you owe more on your mortgage than your property is worth. For example, if you buy a house worth £300,000 with a 5% deposit of £15,000, you’ll have a £285,000 mortgage. If your home value then drops below £285,000 (before you’ve made a decent dent on mortgage repayments), you’re in negative equity.
“With a 5% deposit you are at higher risk of negative equity if property prices fall,” says Thornhill
Negative equity can make moving home difficult, as if you sell, you’ll still owe the bank money. It can also prevent you being able to remortgage and switch to a better interest rate, as lenders may not offer you a new deal.
Because of this, Thornhill urges anyone considering a 5% mortgage to “think carefully about your home purchase”.