Are 95% Mortgages Next For The Chop?

With mortgage lenders cherry-picking borrowers, can you still get a good deal with a small deposit?

UK house prices have fallen 6.9% over the last year, according to Nationwide, and you'd have thought that would be good news for potential first-time buyers as homes should now be more affordable.

But sadly, for wannabe homeowners, while houses are getting cheaper, mortgages are getting more expensive. This week my Foolish colleague, Cliff D'Arcy, mourned the Death Of The 100% Mortgage as the last remaining 100% deal was finally withdrawn. This means no deposit, no mortgage -- simple as that.

We all know the credit crunch has led to far more restrictive lending criteria for mortgage borrowers. In fact, the situation is so dire these days that the best deals are usually reserved for those with a mighty 25% deposit.

It's a huge challenge for most first-time buyers to build up this kind of cash up-front. So what happens if you only have a 5% deposit? Can you still get a decent mortgage deal then? Take a look at some of the lowest-rate 95% mortgages around at the moment:

Top 95% mortgage deals

Source: Moneyfacts, as at 3 July 2008. *Rate will not fall below 4.09%. Mortgages which are exclusive, i.e. are only for graduates or borrowers in specific regions, have been excluded.

The lowest rates for borrowers with a 25% deposit stand at around 5.75% for variable rate tracker mortgages and 6% for fixed rate mortgages. So -- as the table shows -- there is certainly a premium to pay if you need to borrow 95% of the value of your home.

Thankfully, the rates measure up reasonably well compared with the mortgage market as a whole. Given that, the average rate for a tracker mortgage is around 6.50% and 6.70% for a fixed-rate loan, 95% deals don't look outrageously expensive, as long as you can get one of the best-buy deals.

And that applies to the product fees too. Since the average fee for all mortgages comes in at around £800 nowadays, 95% loans are often keenly priced too.

Beware of Higher Lending Charges (HLCs)

Unfortunately, adding on a higher lending charge (HLC) makes some of these deals look pricey. What is an HLC? Typically this charge only applies if you need to borrow a high proportion of the value of the property. And with a deposit of just 5%, you could well fall into this category.

The HLC compensates for the extra risk a lender is taking by giving you a mortgage when you only have a small deposit. The fee is often used to buy an insurance policy which protects the lender from financial loss if you default on your repayments.

HLCs usually disappear once you have a 10% deposit or more. But, don't forget, not all lenders charge an HLC, even if you can't stump up a larger deposit. 

Where HLCs are applied, expect an unwelcome extra cost of well over £2,000*. Given that the HLC can be pretty hefty, it's worth looking out for when you weigh-up which deal to take.

Personally, I think HLCs are an unreasonable charge. Since the rates on 95% deals are already higher than say, 75% loans, you are effectively being penalised twice for having a small deposit. So, try to avoid paying the HLC if you can.

Fee-free deals

True, more than half of 95% deals charge an HLC now but it is still possible to get a fee-free home loan (that is, with no product fee or HLC). In fact, if you're happy to go for a fixed rate, HSBC offer the most competitive fee-free deal, which lasts until 30.09.11. But -- on the downside -- the rate is well above average at 7.39%.

Meanwhile, Nationwide charge just £299 with no HLC, making the lender's mortgage deals pretty low-cost.

Even smaller deposit?

It's become an endangered species, but there is one remaining 97% deal. For those of you with an even smaller deposit of 3%, Halifax is the last lender willing to stick its neck out by offering a loan of up to 97% of the property price. Fixed rates are between 6.59% and 7.04% until 31.08.13, with a product fee of £299 and an HLC of £2,393.

More often than not, the bigger your deposit, the better your mortgage will be. While it's still possible to get a 95% mortgage, you will find the rates aren't quite as competitive. And it's a concern that if the rates continue to climb, 95% loans will become too expensive for many first-timers.

Above all, it's important to sign up to a mortgage deal that's comfortably affordable for you. Over-stretching your budget to get on the property ladder isn't Foolish.

If the figures don't add up, it may be a smart move to put off buying for now and save hard to boost your deposit. Who knows, in that time, house prices may have fallen even further, making dreams of owning your own home a reality.

If you need advice on choosing the right mortgage, speak to one of the brokers at The Motley Fool Mortgage Service.

*Based on a mortgage of £156,750 - 95% of £165,000 purchase price.

More: Watch Out For This Fee | Why Longer Fixed Rate Mortgages Makes Sense