Beware 125% Mortgages

With calls from the Government for more responsible lending it's surprising Abbey has brought a new 125% mortgage to the market.

Home loans are so easy to come by for most of us these days. But in the wake of the debt crisis, mortgage lenders are being urged by the Government to be a little less free and easy with their lending criteria. Mortgage offers of five or even six times the borrower's salary are not unheard of but we may find this liberal attitude to lending could come to an abrupt end.

It's surprising then that mortgage lender Abbey has this week launched a new range of mortgages which require no deposit and allow you to borrow above and beyond the value of your home. Abbey isn't the first lender to offer mortgages of up to 125%. Northern Rock is a big player in this field, but following the recent debacle at the latter lender, home buyers may be keen to take their business elsewhere.

So I think it's a little unfortunate that Abbey chose this week, in particular, to introduce their new 100% Plus Mortgage range.

Let's take a quick look at exactly Abbey is offering -- the range allows you to borrow 100% of the value of your home with the option to borrow up to a further £25,000 as long as the loan-to-value (your borrowing as a percentage of the value of your home) doesn't exceed 125%. You can lock-in a fixed rate over a two or five year period or there is a two-year tracker option.

If you're struggling to get your foot on the property ladder then a deposit-free mortgage with a further borrowing facility may sound like the answer to your prayers. But here's why at The Fool we don't think it's a sensible move:

• You'll instantly be in negative equity - Negative equity means the mortgage secured against your home is higher than its value. Having no equity in your property is risky, particularly if house prices fall and this is exactly what house price indices are beginning to indicate. This isn't too much of a problem while you want to stay put for a while, but if you decide you need to sell your home and its value has fallen, you'll still owe the lender the difference between the outstanding mortgage balance and the sale price.
  
  
• The rates aren't cheap - The interest rates range from 6.99% to 7.85% depending on the deal you go for. Considering Abbey's standard variable rate is 7.84% these rates simply aren't competitive. This is the price you'll have to pay for a high loan-to-value.
  
  
• The additional lending is secured on your home -- on the positive side, this means you can borrow more at a fairly low interest rate. But since your additional debt will run over the same term as the mortgage, it may take a long time to repay and your total interest bill could be high.
  
• To give Abbey its due, it clearly provides a negative equity warning in its literature and the mortgage package allows overpayments of up to 10% each year which means there's an opportunity to increase equity in your home more quickly. The new range may offer greater choice to buyers and re-mortgagers, but at what price?

I can understand why these deals are tempting to first-time buyers if it looks like the only way to purchase a home. But if you can build up even a small deposit of say just 5%, you'll be eligible for better rates and the burden of debt won't weigh you down quite so heavily. Plus if a fall in the housing market does come, postponing that purchase and saving hard in the meantime will put you in a much stronger position.