No More Mad Mortgages!

Major mortgage lenders are scrapping thousands of home loans. While the craziest deals are vanishing, bargains remain for the sensible.

Last October, in The Incredible Shrinking Mortgage Market, I warned Fool.co.uk readers that the UK mortgage market was showing signs of serious weakness. Responding to a worldwide credit crunch which began last summer, British mortgage lenders began withdrawing entire product ranges overnight.

Indeed, in just three months, lenders withdrew 6,400 different mortgage products as they tightened up their lending criteria. Thus, continued liquidity problems in inter-bank lending have caused a steep fall in mortgage lending as lenders turn their backs on riskier borrowers. Subprime lending has been hit hardest, as lenders refuse to lend to people with tarnished credit histories.

The end of mad mortgages

What's more, the credit crunch is now pulling the rug from under the biggest sector of the market: residential mortgages for mainstream customers. Indeed, I'm delighted to see that lenders are deserting the market for loans of more than 100% of a property's value. In the past, I have criticised these mad mortgages, arguing that they place borrowers at far greater risk of negative equity, default and repossession.

When a loan-to-value ratio exceeds 100%, this means that a borrower's debt is greater than the value of their home. Indeed, with a 125% home loan, such as Northern Rock's Together mortgage, a property's value would have to rise by a quarter for a borrower to be left with no equity at all. Yikes!

By this Wednesday, four of the six lenders that previously offered 125% loan to value (LTV) mortgages announced that they were culling these high-risk loans. Abbey, Alliance & Leicester, Coventry BS and Godiva Mortgages are all exiting this sector this week.

The only two lenders still willing to lend in the 125% market are Northern Rock and Birmingham Midshires Solutions. BMS lends solely through brokers, and Northern Rock is clearly in no position to participate for now. In fact, it charges a yearly interest rate of 8.2% for a two-year, fixed-rate Together mortgage, effectively pricing itself out of the market.

The latest candidate for the chop is A&L's PlusMortgage range, which was launched to great fanfare on 1 April 2007. It offered a mortgage of up to 95% of a property's value, plus an unsecured personal loan of up to 30% on top. The personal-loan element was capped at a maximum of £25,000, with the same interest rate charged on both mortgage and loan. In other words, borrowers could bundle existing debts or expenses with their mortgage, up to a limit of 125% LTV.

Alliance & Leicester's annual results, released today, revealed that it lent £625 million under the secured element of PlusMortgage in 2007, plus a further £55 million in unsecured loans. Predictably, no trumpet blast accompanied the withdrawal of PlusMortgage yesterday, with this news failing to feature in A&L's regulatory announcement this morning. I believe that this silent exit indicates that A&L has come to realise that 100%+ loans are inherently riskier. Thus, this lending will probably produce some bad news later down the line...

Mainstream mortgages are now under the cosh

However, it's not just 125% mortgages that are vanishing. Indeed, lenders are becoming increasingly unwilling to lend more than 95% of a property's value. In other words, without a deposit of 5% or more, your options are extremely limited.

In November 2007, there were 41 lenders willing to lend at more than 100% LTV, according to Fool partner Moneyfacts. Today, this number has shrunk to 28, so thirteen firms have pulled out in three months. For example, Bank of Scotland (part of mortgage giant HBOS), withdrew its entire range of 100% mortgages this week. In addition, 100%+ loans are becoming more expensive, with most lenders interested in lending only to professionals and for shared-ownership schemes.

Thus, as mortgage lenders tighten their belts and hunker down for house-price declines, things look worse for overstretched borrowers -- and for first-time buyers in particular. The table below shows how much more expensive it is to borrow without a 5% deposit:

A 5% deposit can save you thousands

Source: Moneyfacts, 19/02/08; based on a £150,000 mortgage over 25 years

As you can see, a 5% deposit gets you a two-year fix from Cumberland BS which costs a total of £22,208 over two years. Without a deposit, a 100% mortgage from C&G will cost £27,464. This comes to £5,256 extra, or £219 a month. Thus, a deposit of £7,900 on a £158,000 property would save you more than five grand over two years. Wow!

With the housing market showing clear signs of weakness, my advice to first-time buyers and home-movers would be to sit tight and save as hard as you can. Currently, you can combine easy access with savings rates in excess of 6.30% a year. You'll find several table-topping savings accounts in The Fool's savings centre.

Then again, mortgage lenders haven't completely turned off the taps. With a decent, regular income, a clean credit history and a reasonable deposit, you should find it relatively straightforward to track down a Best Buy home loan. My advice would be to search the entire market to find the best deal for you. The easiest way to do this is to use a no-fee, whole-of-market mortgage broker, such as The Fool's award-winning mortgage service.

Finally, as mortgage lenders seek to improve the quality of their lending, its quantity must therefore fall. Furthermore, reduced competition and the departure of Northern Rock means more expensive home loans all round. Thus, there's little chance of lending exceeding £80 billion in 2008, versus the £108 billion racked up last year.

With little room for the Bank of England to cut its base rate, there are clear indications of future falls in house prices. Hence, I intend to sit out the storm as a tenant for the foreseeable future!

PS. Since Cliff wrote this article, the final two lenders offering 125% mortgages have withdrawn their products - that's Northern Rock and BM Solutions.

More: Find your ideal mortgage via the Fool | Seven Stupendous Mortgage Deals | Ditch Your Rip- off Mortgage