Interest Rates and Risk – Loan to Value Ratio Hits those buying Property with small deposits

There is a growing differential with the new post recession property market between those having an equity stake in excess of 30 % and those requiring a 90% plus loan.

For a time, it was very difficult to secure a mortgage that was in excess of 90%, despite this being typical just a few years ago. Back in 2007, 800 different 95% mortgages were available to first time buyers.

In recent times the number of loans on offer has tripled and interest rates fallen. January saw Leeds Building Society launch a mortgage that requires a deposit of only 5% and comes with an interest rate of 5.25% (although there’s also a hefty £999 in fees). Newcastle and Ipswich building societies also launched 95% deals, following the launch of Nationwide’s Save to Buy scheme, in which savers who put money aside for at least six months can apply for a 95% loan, and Lloyds’ Lend a Hand scheme, where first-time buyers can access a 95% deal if they can convince their parents to put their savings up as security against the mortgage.

So now that it is possible to obtain 90% mortgages again in the open market, the level of deposit has begun to have a very pronounced affect on the level of interest charged.

On a £150,000 mortgage with an additional equity sum, making the borrowing only a 60% of the property value, a loan can be obtained some £300 more cheaply per calendar month than someone else with the same size mortgage but at 95% of the equity.

Lower interest rates by financial establishments thus appear only to be on offer to those with an ability to offer a greater deposit, creating what is being coined as a ‘two-tier mortgage market’. The gap between these two tiers was increased yet further in mid July as Santander launched a five year, fixed-rate mortgage at 2.99 per cent alongside a similar deal from HSBC, both only for loans worth up to 60% of a home’s value.

Interest itself is, of course, a percentage of the original sum designed to incorporate three components:

  • A component to protect the amount borrowed from inflation;
  • A component to provide the lender with some profit;
  • A component to provide a protection from risk of default on repayment.

It is this third section – the bank’s perception of risk – which puts such a high differential on the loans secured on property.

Of course, lenders have always charged higher rates for borrowers they perceive to be of higher risk, but industry experts, including Ray Boulger of national broker John Charcol, have been commenting on the recent widening of this discrepancy. He said:

“The bigger gap between low and high deposits is here to stay because of new capital rules” in reference to the requirement for a 95% mortgage of about one fifth more capital than an 80% loan of the same size.

According to Halifax, such a discrepancy is holding back the overall housing market. They say six in ten adults believe that the lack of deposit is the biggest barrier to buying a house. Suggestions will no doubt be made, therefore, that banks should be a little less cautious when dealing with prudent mortgage applicants and lend a helping hand to those who need it most.

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