Lenders Tighten The Screws On First-Time Buyers

Nationwide hit the headlines this week after announcing it was hiking up its mortgage rates for anyone with less than 25% deposit. Is this the start of things to come?

Size isn't everything -- except, it seems, when it comes to mortgage deposits.

This week, Nationwide became yet another lender to tighten the screws on its customers, after telling new borrowers that, unless they have a deposit of at least 25%, they will face higher mortgage rates.

Until last Friday, those with a deposit of 10% qualified for the best deals. But now, the bank which prides itself on offering competitive rates to all its customers, and not just to `brand new customers only' has dealt a blow to many new borrowers. It has announced that rates will rise by 0.2% on mortgages between 75% and 95% of the value of a home.

The changes will virtually wipe out the impact of this month's earlier base rate cut. It means that someone taking out a new deal with Nationwide will now have to stump up a mighty £50,000 deposit if they want the best deal on a £200,000 mortgage.

But beyond the headlines and sensationalism, is Nationwide's decision really such a big deal?

Old Dog, New Tricks

In truth, mortgage lenders have offered better rates for those able to raise a bigger deposit for years.

For example, Bristol and West's offers a five year fixed-rate mortgage at a rate of 5.65% if you have a 25% deposit, and 5.95% if you can only manage a 5% deposit (a fee of £999 applies).

Similarly, NatWest offers one fixed rate at 5.39% if you have a 25% deposit, and another at 5.74% if you only have a 5% deposit (product fees of £1,299 and £699 apply respectively).

Some lenders require will even ask for more than a 25% deposit nowadays. For example, to get the best rate for Woolwich's Lifetime tracker mortgage of 5.84%, you'll have to find a mighty 40% deposit.

Not easy, when you consider the average price of a home in England and Wales is around £174,000.

Setting The Trend?

Personally, I think Nationwide's decision - in itself - is not that newsworthy. The real significance lies in the fact that, because Nationwide is such a big mortgage lender, they could be starting a trend that other lenders may decide to follow.

Nationwide said their decision to increase their rates for borrowers with 10% deposits was largely due to higher funding costs and the need to adapt to changes in the market, as lenders now look to manage the risk profile of customers.

Only last week, four of the six lenders which had previously offered 125% loan to value (LTV) mortgages announced they were pulling these products from the market.

And this is not a suprising move, considering the downturn that has recently occurred in the housing market. Lenders were more willing to lend more money to prospective borrowers when house prices were rising, because there was very little risk that a borrower would end up in negative equity (this is when you owe more on your mortgage than your property is worth).

As prices start to cool and the chance of homeowners falling into negative equity increases, lenders are becoming less willing to offer mortgages to borrowers with small deposits.

So to sum up: after a decade of boom, lenders are becoming more cautious about who'll they'll lend to. If you were a lender, wouldn't you avoid borrowers with small deposits who may be overstretching themselves to get on the housing ladder at the beginning of what could be a crash in property prices?

Beginner's (Bad) Luck

Undoubtedly, while the lenders are busy protecting themselves, the biggest losers in all this will - as usual - be first time buyers, who typically haven't got huge deposits.

For years, many first-time buyers have been priced out of the market, especially in urban areas such as London where house prices have risen exponentially over the last decade.

How painfully ironic that, just when prices are starting to cool down and property is becoming more affordable, fewer lenders are willing to offer mortgages to borrowers with small deposits, and are increasing rates on the few deals still available. This means first-time buyers could be priced out of the housing market once again, only this time by the mortgage lenders.

That's quite a bleak vision of the future and, the good news is, there's no need to panic just yet. Right now, there are still many competitive deals to be found for borrowers with 10% deposits. But  bear in mind that the smaller your deposit, the more difficult it will be to find a cheap mortgage deal. If you're in this position, I would highly recommend using a broker who can search the whole of the market and advise you on the best deal available (The Motley Fool Mortgage Service offers such a whole-of-market service).

Playing Detective

If you're determined to hunt out those elusive cheap deals yourself, where should you look?

There are some suggestions that prospective borrowers could turn their attentions to banks funded through the European Central Bank (ECB), such as Abbey or Bank of Ireland, as the ECB is more willing to provide funding for mortgages than the Bank of England.

Abbey's two year fixed rate is currently 5.47% if you can raise a 10% deposit. However, the rate comes with a product fee of £1,999, and the maximum you can borrow is £250,000. So perhaps not so generous after all...

Smaller building societies could be another place to sniff out a good deal. For example, Northern Rock's neighbour Newcastle Building Society is currently offering a rate of 4.84% on its discount rate mortgage for borrowers with a 10% deposit  until March 2010. However, the mortgage comes tied with a hefty completion fee of 2.5% of the loan. For a £200,000 mortgage, that's a massive £5,000. Another reason why it's important to check the small print or get professional advice from a broker about what is the best deal.

Finally, even though there are still some competitive deals around for mortgage borrowers with 10% deposits, never forget that size really does matter in this market. The bigger your deposit, the more likely you are to get a better rate.

More: Death Of The Cheap Mortgage Deal / How To Buy Property At Auction

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