100% Mortgages: Friend Or Foe?

Should you risk a no-deposit mortgage?

With most mortgage providers now looking at 'affordability' rather than multiples of salary as key to the size of a home loan, you may be able to borrow more than you originally thought. A 100% (or higher) loan to value mortgage means no deposit is required, attractive to first-time buyers or starting-again divorcees with limited assets. But should you take the risk? If not exactly troubled, these are at least cautionary times for the housing market.

There have been four interest rate rises since last August and although the Bank of England kept the base rate on hold at 5.5% this month, there is the threat of further hikes to come; some predict a 6% level by the end of the year.

Rising mortgage interest rates coupled with increasing house prices add up to a worsening of affordability constraints for first-time buyers. Halifax research shows an increase of almost 21% since June 2005 in the average price of a UK house, to £197.000. The Council of Mortgage Lenders (CML) reports that mortgage interest payments for aspiring home owners are at their least affordable level for 15 years; an average of 18.7% of income is now needed to cover interest payments. Seasoned home movers are also finding it tough, now parting with an average of 16.3% of income to service the mortgage.

But More, Means More

The bigger the mortgage, the bigger the monthly cost.  Four or five multiples of income are now required to get a foot on the property ladder (10 times is the prediction for the next generation of first-time buyers) and there has been a huge growth in the100% mortgage market for people without deposits.

The popular route to home ownership is the fixed rate mortgage deal, the choice of four in five first time buyers, according to the Royal Institute of Chartered Surveyors (RICS). In April, reports the CML, 88% of first timers and 72% of home movers opted for a fixed interest rate over a set period. Meanwhile, with some 2 million fixes coming to an end over the next 18 months, many borrowers could be faced with a significant increase in their monthly outgoings.

A RICS spokesman said that the price of mortgage fixes has risen consistently in 2007 and "is set to rise further as interest rate increases and lingering inflation concerns raise longer-dated borrowing costs."

The housing market could go into reverse gear within the next 12 months. Risking a 100% no deposit mortgage now could leave you languishing in negative equity land should house prices fall. You could owe more money than your house is worth.

In the early 1990s a crashing property market (following the late 1980s boom) coupled with high interest rates and rising unemployment meant that tens of thousands of homeowners defaulted on loan repayments and had homes repossessed. It could be argued that a similar scenario may be replayed now.

Ominously, some might think, is Abbey's recent announcement of the availability of 100% mortgages for the first time since the early 1990s. The bank is joining a growing number of lenders who offer a no deposit mortgage.

Abbey offers a choice of fixed and tracker mortgage products, either with or without arrangement fees; for example, the two-year fix at 6.35% carries a fee of £995. The rate is 7.19% for remortgagees (separated partners starting again) on a two-year fix, but there is no arrangement fee. An affordability calculation determines how much you can borrow (up to five times income) and there is no higher lending charge (HLC).

This is a plus as Moneyfacts research shows that 75% of lenders levy a HLC which typically kicks in when you exceed the 90% loan to value (LTV) mortgage threshold.

The purpose of the HLC is to cover the cost of the lender's insurance against the risks of you defaulting and the lender having to repossess and sell on your home. You might think it a bit rich that you foot the HLC bill when it offers you no benefit or protection. In fact, rather than scraping together the 3% deposit for a maximum 97% mortgage from the Halifax, say, with the add-on arrangement fee and HLC, better value could be achieved by borrowing 100% from a lender who does not inflict the HLC.

The HLC can be applied, at varying percentages, on the difference between a 75% LTV and the loan actually taken. For example, 12% is charged by Royal Bank of Scotland on the difference between 75 and 100% LTV. This amounts to 3% of the entire loan; a first-timer borrowing 100% on a property valued at £100,000 (25 year repayment mortgage at 5%) would forfeit £3,000. If added to the loan, rather than paid upfront, this figure will exceed £5,000 over the 25 year term.

Why limit yourself to a 100% LTV mortgage, anyway? Several lenders offer in excess of this amount, as much as 125% (eg Birmingham Midshires, Northern Rock) and 130% (Mortgage Express). Apart from dispensing with the need for a deposit, the extra funds can be used to defray the costs of stamp duty, legal fees, new furnishings etc.

However, the price, of course, is a higher interest rate and a greater potential for long term negative equity. How certain are you that employment or lifestyle changes will not dictate the need to sell before then? And if there is a recession in the housing market you have a serious problem.

 

 

© www.Moneyextra.com

 

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