Kill Off This Housing Rip-off!

The property market has been on a ten-year winning streak, so why do mortgage borrowers still pay this extortionate fee?

I spent the final years of the 20th century working for one of the UK's biggest general insurers.

Being a giant in many fields, this venerable insurance company was one of the leading underwriters of mortgage indemnity guarantees (MIGs), which lost it hundreds of millions during the Nineties. When I mention MIGs, I'm not talking about Russian military aircraft -- I'm referring to a special kind of insurance policy which mortgage lenders use to protect themselves against falling property prices!

For example, let's say that you buy a £100,000 property with a £90,000 mortgage. Over time, you get into difficulty with your repayments and, ultimately, your mortgage lender steps in and repossesses (seizes) your property. The lender then sells the property at auction for, say, £70,000, leaving it £20,000 shy of the original loan (your £10,000 deposit has vanished, too).

The good news for the lender is that it can then reclaim some or all of its £20,000 loss, thanks to a mortgage indemnity guarantee that it had wisely taken out to protect itself against defaulting borrowers. These days, these policies tend to be called mortgage indemnity premiums (MIPs) or, more often, higher lending charges (HLCs), but their purpose hasn't changed.

Now here's the funny bit: guess who pays the premium for this insurance policy which protects only the lender? No, not the lender itself; in fact, it's the borrower who pays the premium so that the lender can enjoy this additional peace of mind! Furthermore, the insurance company which paid the lender's £20,000 claim can then chase the borrower for reimbursement of this sum, even several years down the line. What a swizz, eh?

(If you don't believe that insurance companies can be bothered to track down defaulting borrowers, then think again. Eleven years after my friend handed back his house keys to his building society after losing his job in the last recession, his society's HLC insurer presented him with a five-figure bill and a threat of court action if he didn't come up with a repayment plan. Honestly!)

The UK property market has risen every year since 1996, yet the majority of mortgage lenders still cover their rears by making borrowers pay higher lending charges. Although the Portman BS last week announced that it would no longer apply HLCs to its fixed-rate mortgages, three-quarters of mortgage lenders still hit new borrowers with these fees, according to independent financial analyst Moneyfacts.

What's more, a higher lending charge can add thousands of pounds (even tens of thousands!) to the cost of buying a home, especially if this fee is added to the mortgage and interest is charged on it, as is normally the case.

Typically, this fee ranges from 7% to 8% of the risk to be covered, but can stretch as high as 12%. HLCs aren't usually charged on loans of less than 90% of the property price, but if you can't afford at least a 10% deposit, then you can expect to pay an HLC on all borrowing over 75% of the purchase price. Here's an example of how one HLC is calculated:

• Property price: £100,000
• Mortgage: £100,000 (a 100% mortgage)
• HLC rate: 12% of any borrowing in excess of 75% of the property's value (over £75,000)
• Excess risk: £25,000
• HLC charged: £3,000 (12% of £25,000)

If you can't afford to pay this £3,000 fee upfront (and, given that you're arranging a 100% mortgage, you're unlikely to have a spare three grand), then you're forced to add it to your home loan. For a 25-year repayment mortgage with an annual interest rate of 5%, this fee will add an extra £5,262 to the lifetime cost of your mortgage. This is more than a twentieth (5%) of your original purchase price -- ouch!

Of course, the decade-long house-price boom has forced prices ever upwards, making most HLCs all-but-unnecessary up to now. Nevertheless, all winning streaks come to an end, so lenders are reluctant to end their reliance on these rip-off policies. Naturally, they recall all too well how valuable these policies were throughout the Nineties, during and after the last property crash!

However, some lenders have changed their risk strategy: instead of charging HLCs, they charge higher interest rates to borrowers with smaller deposits, which I think is a fairer approach. After all, who wants to pay for an insurance policy which protects someone else and offers no benefit whatsoever to the buyer?

So, when you're comparing those mouth-watering mortgage rates, be sure to look beyond the slick advertising. With an expensive HLC, your savings from a competitive rate can be wiped out on day one, so check the small print and ask for more details. For the record, according to Moneyfacts, these mainstream mortgage lenders don't charge HLCs:

• Bradford & Bingley
• Buckinghamshire BS
• Cambridge BS
• Capital Home Loans
• Catholic BS
• Cheltenham & Gloucester
• Chesham BS
• Co-operative Bank
• Coutts & Co.
• Cumberland BS
• Derbyshire BS
• Ecology BS
• Egg
• First Direct
• Future Mortgages
• Heritable Bank
• Hinckley & Rugby BS
• HSBC
• ING Direct (UK)
• Intelligent Finance
• Lloyds TSB Scotland
• Market Harborough BS
• Monmouthshire BS
• Mortgage Express
• National Counties BS
• Newbury BS
• Northern Bank (NI)
• Northern Rock
• Prudential Banking
• Scottish Widows Bank
• Smile
• Standard Life Bank
• The One Account
• UCB Home Loan Corporation
• Vernon BS
• Victoria Mortgages
• Woolwich

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