The concept of a mortgage deposit is very simple; you put down a deposit on a property and borrow the rest from a mortgage lender.
When you dig a little deeper, it does become a little more complicated, and there are numerous issues to take into consideration.
Those who follow the mortgage industry will be aware that the Financial Conduct Authority (FCA) has introduced a number of regulations over the last decade or so.
The Financial Shock of 2008
Before we look at mortgage deposits in detail, it is worth rewinding a little so that we can understand why regulators have been so active over the last decade. If we look back to the US mortgage crisis of 2008, which resulted in the most severe economic downturn since the great depression, this prompted huge change across the world.
The collapse occurred as a consequence of the extremely strong US homeownership trend which had been ongoing for some time. As the US mortgage industry became more and more competitive, lenders were working on wafer-thin margins, and some were lending funds to those who were quite obviously unable to repay them.
At the time the idea was simple, the US housing market was going from strength to strength, and even those with suspect finances would be able to sell up, repay their mortgages, bank a profit and move on.
When the cracks first began to emerge in the sub-prime US mortgage market, they were ignored. As sub-prime mortgage lenders began to struggle, some are going out of business and clients defaulting on their debts; the problem suddenly became real.
To make matters worse, some of this sub-prime mortgage income had been converted into “high grade” income bonds and sold, often with guarantees, to investors. The contagion spread from the US sub-prime market to the main market, impacting money market rates, mortgage income bonds, the risk/reward ratio and ultimately, there was a huge increase in default numbers.
Very quickly, this contagion spread across the worldwide mortgage market and consequently led to the most severe economic downturn in a generation.
This is what prompted regulators across the globe to revisit how they regulated/managed their local mortgage lending markets.
Ways to Raise a Property Purchase Deposit
There are numerous ways in which you can raise a deposit for a property which include:-
- Family loan
- Sale of investments
- Cash in insurance/savings policy
In theory, it may be possible to take out a stand-alone loan to cover a property purchase deposit, but this would not necessarily go down well with mortgage lenders.
When looking at your finances, it would be obvious that you have borrowed additional finance to fund the deposit, effectively a 100% mortgage. Potential high-risk alert!
The main problem for those looking to acquire property at this moment in time is the huge increase in UK house prices over the last 40 years or so. For example, with the average UK property now valued at in excess of £200,000, a 25% deposit on a property purchase would equate to £50,000.
As we will cover later in this article, there are some companies who will offer 95% mortgages which equate to a deposit of just 5%, i.e. £10,000 in the above example.
The following table will give an idea of the average target property purchase deposit across areas of the UK in 2019:-
|Area||Average property purchase deposit|
|East of England||£24,001|
|Yorkshire & Humber||£20,750|
Risk Reward Ratio
Many people looking at the mortgage market may wonder why mortgage lenders are not willing to offer 100% of the value of a property.
Surely, with the client making mortgage payments from day one, there would be a constant reduction in the loan capital.
This certainly simplifies the situation, but there are numerous factors to take into consideration such as:-
Headroom is best described as the gap between the value of a property, and the mortgage funding was taken out on the property. The greater the headroom, the greater the insurance policy for the mortgage lender and hence the greater likelihood they will offer a lower than average interest rate.
For example, if the headroom was 20%, i.e. the client had put down a 20% deposit, then the value of the property would need to fall by more than 20% before negative equity came into play.
If the headroom is just 10%, then a 15% reduction in the value of the property would put the client into negative equity, leaving the mortgage lender exposed in the event of the client experiencing financial difficulties.
We will look at income in more detail but back in 2017 the FCA limited retail banks in the UK to a maximum 4.5 income multiple for an individual and the same for joint (income) mortgages.
This is part of the mortgage affordability test which will determine whether mortgage finance will be forthcoming.
While the level of deposit a customer is able to put down against a property purchase will have a huge difference on the interest rate in terms of a potential mortgage, additional collateral will also help.
This may come in the shape of another asset, investments or perhaps some kind of policy which is due for payment in the future.
Loan To Value Ratio Explained
When looking into mortgage deposits and mortgage arrangements, you will hear the term LTV ratio mentioned on numerous occasions. This is the loan to value ratio, which can vary significantly but effectively reflects mortgage lending as a percentage of the value of the property in question.
For example, if a buyer was to put down a 20% deposit on a £100,000 property purchase, they would require £80,000 in mortgage funding to complete the purchase.
This equates to an LTV ratio of 80%, i.e. mortgage funding is 80% of the property value.
The LTV ratio can be a useful barometer of the short to medium-term outlook for both the UK economy and property market. In buoyant markets, the LTV ratio can creep back towards 100%, although 100% of mortgages are very rare these days.
We have seen the emergence of some 95% LTV ratio mortgages, but they really are towards the top end, and you would expect significant financial backing to secure this kind of mortgage.
However, the market can very quickly tip on its head in the event of a downturn, thereby exerting pressure on property prices.
It will depend upon the type of mortgage you are looking for, residential purchase or a buy to let, for example, as to the LTV ratio. The LTV ratio will also be impacted by the underlying financial strength of the customer and the affordability factor.
In some instances, a proposed mortgage LTV ratio may fall as low as 50%, which would leave the buyer to make up the balance. In reality, this balance could be made up by the release of equity in additional properties, investment redemptions or other funding.
However, it is fairly obvious that for first-time buyers, they need to have a first-class credit rating to maximise mortgage funding.
Percentage of Deposit Required
As we touched on above, the deposit required to purchase a property is directly linked to the LTV ratio and as a consequence can change. In the aftermath of the 2008 US mortgage crisis, we saw mortgage deposit requirements increase to around 25% in the UK.
Unfortunately, many first-time buyers were effectively priced out of the marketplace and pushed towards the rental property. As you might be aware, this led to a huge surge of investment in buy to let properties thereby pushing up UK property prices and creating a vicious circle.
Just prior to the coronavirus pandemic the UK property market had been fairly strong and appeared well set for the future. Yes, we had the challenges of Brexit on the horizon, and in reality, the market was being supported by historically low UK base rates.
While mortgage rates tend not to follow base rates on a like-for-like basis, they will certainly dictate the short term trend of mortgage rates. At this moment in time, some mortgage companies are offering 5% deposits, although it is safe to say that they would request additional collateral or charge significantly higher interest rates than the norm.
Again, this reflects the basic risk/reward ratio, which ultimately dictates whether mortgage funding will be forthcoming.
Annual Earnings Required
When looking to acquire a property, it is best to work backwards and calculate the maximum mortgage you may be able to obtain on your annual income.
You will see from the following examples show an increase in earnings or even a joint mortgage can make a huge difference to the financial leverage available.
|Income||Potential Mortgage (4.5 x income)||Property Price||Deposit required|
|Individual – £30,000 annual income||£135,000||£200,000||£65,000 (32.5%)|
|Joint – £45,000 annual income||£202,500||£200,000||Scope to negotiate|
In reality, a mortgage lender would still require a significant deposit even if the client’s joint spending power was in excess of the property price. The average is currently around 20% but could be as high as 30% or even as low as 5%.
There are also various government schemes to assist first-time buyers which require just a 5% deposit with the authorities providing additional funds.
These schemes see the authorities taking a stake in each property which has the potential to increase in value as the price of property rises.
So, while first-time buyer schemes are very useful for those looking to climb onto the ladder, the authorities would maintain a stake in the property until it was sold or the homeowner was able to buy them out.
For many years retail banks dominated the UK mortgage market, although just recently the emergence of numerous private banks and niche lenders has begun to erode their market share.
Indeed, many retail banks, operating under different regulations and business models to private banks/niche lenders, saw their balance sheets obliterated in light of the 2008 US mortgage led crisis – with many requiring government bailout funding.
This created an opportunity for private banks and niche lenders, as well as the emergence of crowdfunding property finance platforms. As a consequence, retail bank share of UK mortgage lending has decreased and is under significant pressure even today.
In many ways, this has exposed the inflexibility of UK retail banks with regard to mortgage funding. Maybe they became complacent due to their historic domination of the UK mortgage market?
Private Banks/Niche Lenders
While private banks and niche lenders tend to focus on high net worth individuals, they will often look at sub-£1 million mortgages – especially if there is potential to expand client relations going forward.
Operating under very different regulations (and funding models) they tend to be more flexible than their retail banking counterparts and as a consequence, continue to dominate the high net worth and ultrahigh net worth mortgage markets.
Often described as wealth management companies, private banks tend to offer an array of different financial services with mortgage lending often seen as a way to entice new customers in.
For many years private banks and niche lenders operated behind-the-scenes with their traditional point of contact being mortgage brokers. The situation has changed significantly in recent times with private banks and niche lenders more visible than ever before.
While this has placed pressure on the traditional UK retail banking sector, there have been significant benefits for retail customers with continuous pressure on mortgage interest rates and mortgage deals.
Different Types of Mortgages
If you have looked into the UK mortgage market, you will be aware of the two basic types, interest-only mortgages and repayment mortgages.
As the name suggests, with an interest-only mortgage, you are only obliged to pay the interest on the mortgage capital and repay the capital at the end of the term.
As the mortgage lender is still at risk for the total capital until the end of the mortgage term, you may require a higher deposit than if you had a repayment mortgage.
One of the main benefits of interest-only mortgages is reduced repayments which will help an individual’s cash flow.
A repayment mortgage is an arrangement whereby you pay higher monthly payments than an interest-only mortgage because you are paying back part capital/part interest.
As a consequence, the longer the mortgage goes on, the more capital is repaid, and therefore the interest reduces. There will be a crossover point when the majority of the monthly payment goes towards repaying capital as opposed to covering interest in the early days.
Therefore, all things being equal, you may be able to negotiate a better deposit/LTV ratio with a repayment mortgage.
There are also other types of mortgages to take into consideration such as:-
It may be possible to have a guarantor join in your mortgage arrangement as a means of reducing the initial deposit and increasing the LTV ratio. As we touched on above, this is simply down to a reduction in the perceived risk/reward ratio – if you default on your payments, then your guarantor is liable.
Obviously, any guarantor would need to be checked with regards to the mortgage affordability calculation before being allowed to join in.
Buy to Let Mortgage
The deposits required on a buy to let mortgage tend to be greater than those associated with homeowner mortgages.
However, for those looking to build large buy to let portfolios, there may be the option to crystallise equity in earlier investments to fund future deposits.
This leveraging of assets/equity can be extremely useful, but it must be done within a controlled environment so as not overstretch your finances and potentially bring your whole portfolio crashing down.
Finding the Best Mortgage Deals
As a non-specialist looking at the UK mortgage market, there are literally thousands and thousands of mortgages available.
Some will focus on different client types, others offer enhanced LTV ratios, some of them will focus on government schemes, but very often the rate in the public domain is negotiable.
Against this background, how do you find the best mortgage deals?
While some mortgage brokers have attracted unhelpful reputations in years gone by, the industry today is very different from that of 20 years ago.
There are tighter regulations, more transparency and the option to choose a tied mortgage broker or an independent broker – who in theory has access to the whole market.
So what are the pros and cons of using mortgage brokers?
As we touched on above, many of the mortgage rates and terms in the public domain are negotiable behind the scenes. While there is a natural inclination to assume that independent brokers offer the best value, and they can in many cases, those tied to a relatively small group of lenders can also offer value.
As tied mortgage brokers, they have very close relations with their tight group of lenders and can often negotiate extremely competitive terms. The greater the flow of potential mortgage deals, the greater value the tied mortgage broker is to a lender.
As a consequence, they can negotiate some very attractive deals.
The situation is a little more obvious when it comes to independent mortgage brokers who will likely have access to more than 300 individual lenders across both the UK and the worldwide mortgage market. Of course, they will build up relationships with specific lenders.
Still, the beauty of using an independent broker is the fact they are not tied to any group or individual mortgage lender. This can be especially useful, where, for example, a challenging financial scenario requires a niche mortgage lender.
If the lenders within a tied mortgage broker’s group of contacts don’t specialise in this specific scenario, it may be difficult to negotiate the best terms.
Private Banks/Niche Lenders
As we touched on earlier in this article, private banks and niche lenders very much come to the fore since the 2008 US sub-prime mortgage crash. They have certainly put the UK retail banks under huge pressure and continue to take market share.
As private banks and niche lenders operate under different regulations than those forced on retail banks by the FCA, they can be more flexible – in many cases more competitive. You will often find that even though some private banks/niche lenders are more visible, and they openly promote their services, the best deals are only available on an invitation-only basis.
Therefore, in many cases, assuming your criteria suits the business model of private banks/niche lenders there may be some very attractive deals to be negotiated. Tied mortgage brokers will have access to private banks/niche lenders, but as the term suggests, they will not have access to all market participants.
That said, even relationships with a relatively small number of private banks/niche lenders could still offer scope to negotiate very attractive deals.
In years gone by there were serious concerns that mortgage brokers were receiving huge commissions from mortgage lenders to whom they referred business. Thankfully, we now live in a very transparent financial sector where any fees/commissions or specific arrangements between mortgage brokers and mortgage lenders are revealed before any negotiations start.
Whether a mortgage broker is directly charging clients, conditional on successful fundraising, or receiving commission from a mortgage lender, everything is upfront and transparent. Indeed, many homebuyers prefer to pay commission direct to mortgage brokers where they have successfully raised funds on acceptable terms.
In many ways, this simplifies the relationship and ensures that everybody knows where they stand.
The required deposit, and as a consequence LTV ratio, can vary significantly in line with economic trends and expectations for the future. Interestingly, at the moment, UK base rates are at a historic low which has provided a huge boost to liquidity for the mortgage industry.
On a purely economic basis, we are moving away from the coronavirus pandemic yet the challenges of Brexit loom on the horizon. There are expectations of a significant drop in UK GDP, which will have an impact on unemployment and consequently a knock-on effect on the property market.
However, this will be softened somewhat by the current level of UK base rates which have remained at or near historic lows for more than ten years.
The simple fact is, the greater the deposit you are able to put down on a property purchase, the less mortgage funding you will require. This will reduce the risk/reward ratio for mortgage lenders and potentially allow them to offer competitive rates compared to the “norm”.
The situation is turned on its head if only a small deposit is available and many mortgage lenders may step away from such scenarios.
So, we have the LTV ratio, property purchase deposit, income multiples, affordability calculations and the potential use of guarantors/additional collateral.
There’s a lot to think about!
How Can The Mortgage Bank Help?
Here at The Mortgage Bank, we have partnered with some of the UK’s leading mortgage brokers.
They have already helped thousands of people get the best mortgage deal even people that have been refused before, and they can do the same for you.
Choosing an independent adviser means they won’t recommend a scheme unless they are sure it is in your best interests. Their advice is also regulated by the FCA, which gives you an additional layer of protection.
If you would like to speak to one of these brokers who can provide you with a ‘whole market quote’ then click on the below and answer the very simple questions.