Opinion: we don’t need to panic about high-LTV mortgages

Competition is pushing down rates for borrowers with tiny deposits, but this shouldn't be seen as a return to irresponsible lending.

There have been worse times to be a first-time buyer.

While house prices continue to rise in most areas, the rate of growth has dropped significantly of late.

Back at the time of the Brexit referendum, annual UK house price growth stood at a massive 8.2%, but the latest figures from the Office for National Statistics show this has slumped to just 1.7% in the 12 months to December 2018.

That’s the lowest rate of annual growth since June 2013.

There’s been good news on the mortgage front too, with new data from Moneyfacts suggesting that the margin between the rates on offer for borrowers with a 5% deposit compared to a 10% deposit have been slashed right down.

No matter what type of deal you want, make sure you get the best rate available to you. Compare mortgage rates on loveMONEY when you have a spare minute.

Trimming margins

According to Moneyfacts, the average interest rate available on a maximum 90% loan-to-value (LTV) mortgage today is 2.65%, while for 95% deals it stands at 3.30%.

That’s a difference of just 0.65%.

By comparison, back in January the difference was 0.77%, while going back to October 2017 the margin was a whopping 1.57%.

What’s particularly notable here is that the average two-year fixed rate for borrowers at 90% has changed only a little since October 2017, rising by 0.03%, yet for borrowers at 95% the typical rates have fallen by 0.95% over the same period.

Should you lock into a 10-year fix to protect against uncertainty?

First-time buyers benefiting from competition

This trimming of rates at high LTVs is mainly down to competition.

Lenders are desperate for the business and, while they have always demanded higher rates from borrowers with small deposits due to the perceived extra risk that comes from lending to them, the sheer number of lenders active in this part of the market means that they can’t milk these borrowers as they may have done before.

This is obviously great news for any would-be first-time buyers.

Saving up for a deposit is not exactly easy, and getting a 5% deposit together is going to be more straightforward and quicker than having to hold off buying until you manage at 10% deposit.

A question of affordability

It’s worth noting that last month figures from the Bank of England and Financial Conduct Authority revealed that the proportion of lending at more than four times a borrower’s annual income stood at 47% in the last quarter of 2018.

That’s the highest value since the two organisations started publishing these stats on a quarterly basis back in 2007.

So should we be concerned that these ‘risky’ mortgages are being handed out willy nilly?

You can’t mention the concept of high LTV mortgages without someone piping up to bemoan Northern Rock’s Together mortgage – which coupled a 95% LTV mortgage with an unsecured personal loan, allowing borrowers to effectively borrow more than the value of the property – the deal that's still seen as the embodiment of the reckless lending prevalent around the time of the financial crash.

But this isn’t entirely fair. Thanks to rules brought in since the crisis, lenders have to follow far stricter affordability tests when assessing a borrower’s application.

It isn’t enough to simply lend them four times their income, irrespective of their other financial commitments – a borrower has to show they can comfortably cover the repayments, not only today, but also should rates rise.

Indeed, this is a significant factor behind lenders increasingly offering mortgages with 40-year terms, rather than the 25-year terms that were common in years past.

In order to pass those affordability tests, borrowers are having to accept far longer mortgage terms, as this cuts down the size of their monthly repayments, even though it then costs much more in the long term.

What about the risks?

Generally, there is a slightly higher risk of lending to a borrower with a small deposit in terms of them falling into default.

But that’s why these deals come with a higher interest rate anyway, and the reality is that you can still get a much lower rate with a 25% deposit than a 5% one, even with the recent changes.

Besides, with the affordability tests lenders have to go through, they aren’t going to approve a mortgage unless they are pretty confident the borrower can handle the repayments.

The risk really lies in the threat of negative equity. If you borrow with only a small deposit, then the chances of dropping into negative equity – where your outstanding mortgage is greater than the value of the property – are obviously more significant.

After all, if you buy a property with a 5% deposit, it won’t take a huge change in prices to leave you in the red, whereas this is much less likely if you buy with a 20% deposit.

House price growth has slowed sharply, in no small part due to the Brexit vote, and with the shambles of our European exit ongoing there is a risk that prices will continue to stall or even fall. In London prices have dropped over the last year.

But given the continued shortage of homes, prices are unlikely to drop by much, if at all. And besides, negative equity is not a death sentence – you can get out of it by overpaying on your mortgage or finding ways to boost the value of your home.

Negative equity doesn’t mean you will be repossessed, it just means you might find it tricky to remortgage or move.

It’s understandable that when things start looking attractive at high LTVs people get nervous.

The scars of 2007 haven’t fully healed.

But equally, times have changed and if we are to have a healthy and functioning housing market, we need first-time buyers to be able to access the market. And competition among low-deposit mortgages is a good way to do it.

No matter what type of deal you want, make sure you get the best rate available to you. Compare mortgage rates on loveMONEY when you have a spare minute.