Saving up for a deposit on your first home can be tricky, but low deposit mortgages may offer a quicker route to homeownership.
In this article, we’ve got all the info you need on getting a mortgage with a small deposit.
What are low deposit mortgages?
A low deposit mortgage lets you buy a property with a deposit as low as 5% to 10%. (That is, 5% to 10% of the value of the property you’ve got your eye on.)
That means you’ll be borrowing up to 95% of the cost of your new home from your mortgage lender.
Say you want to buy a house valued at £200,000. If you can get a 95% mortgage, you’ll only need to provide a £10,000 deposit.
The amount you borrow for your mortgage is also known as the loan-to-value (LTV) ratio. So if you get a loan that’s 95% of the property’s value, you’ve got a 95% LTV mortgage.
How easy is it to get a low deposit mortgage?
Low deposit mortgage deals were getting pretty scarce until recently. That’s because mortgage lenders see them as a high risk.
Think of it this way: the value of your home is the lender’s “security” – if you stop repaying your mortgage loan, they can repossess your property, sell it, and get their money back. But if house prices fall and you’ve got a high LTV mortgage, your home might end up being worth less than the amount you have left to pay on your loan. In that case, the lender would lose out.
The good news is, the UK government has now taken steps to reduce the risk for lenders and encourage them to offer more low deposit mortgages. They’ve done this through the new mortgage guarantee scheme, launched in April 2021.
With this scheme, the government guarantees the portion of the mortgage that’s over 80%. So, if a homeowner defaults (can’t make the repayments) on their 95% mortgage loan, the government will pay the lender 15% back.
Essentially, the scheme aims to level the playing field between low deposit mortgages and higher deposit mortgages. And it’s already had an impact: several big high-street lenders are already offering more low deposit mortgages.
Let’s take a closer look at the scheme and whether it could help you get a mortgage.
The mortgage guarantee scheme
Scheduled to run until December 2022, the scheme is aimed at aspiring homebuyers who can provide a 5% to 9% deposit. Here are the criteria you’ll need to fulfil if you want to benefit from it:
- You need to be a first-time buyer or someone wanting to move home
- Only properties of up to £600,000 in value are covered by the scheme
- The mortgage has to be for your main residence (not for a second home or buy-to-let)
- New-builds aren’t included (they’re covered by a different scheme, which we talk about below)
- Only repayment mortgages are covered, not interest-only. That is, mortgages where you you’ll need to pay back both interest and a chunk of your loan each month
- To get a low deposit mortgage under the scheme, you’ll still need to pass the usual affordability checks (to make sure you’re in a good position to pay back the loan).
Another thing worth bearing in mind is that lenders taking part in the scheme are obliged to offer a 5 year fixed rate mortgage deal. That’s where the interest rate doesn’t change for 5 years, so you always know how much your monthly mortgage payments will be during that time. You might want to ask lenders about this (if it’s something that interests you), but remember that you’d still have to satisfy a lender’s eligibility criteria to be offered the deal.
If you’re a first-time buyer with a small deposit, you’ve also got the option to take advantage of another government scheme: Help to Buy.
Help to Buy equity loans
You can buy a new-build home with as little as a 5% deposit through the Help to Buy scheme. To cover part of the cost, the government will give you an equity loan of 5% to 20% of the property’s value (or up to 40% in London). You don’t have to pay interest on the loan for 5 years either! Then the rest is covered by a Help to Buy mortgage.
Caveats? The scheme is only open to first-time buyers, and there’s a cap on the purchase price of the property you can buy. The cap is different depending on your region, but it’s between £186,100 and £600,000 in England. (Scotland and Wales have slightly different Help to Buy schemes.)
How much can you borrow with a low deposit mortgage?
Usually, you can borrow up to 4.5 times your annual income (or your combined annual income if you’re applying with a partner or family member) on a mortgage. This is the case for both lower and higher deposit mortgages.
So, for example: if you want to buy a £200,000 home with a 5% deposit, you’ll need to get a mortgage of £190,000. This means you’d have to be earning about £42,200 a year.
Our mortgage calculator can give you a clue about what size of mortgage you could afford based on your current income.
How do you go about applying?
Applying for a low deposit mortgage is pretty much like applying for any other mortgage – although there are a couple of extra steps if you’re taking advantage of Help to Buy.
Once you’ve had an offer accepted on a property, you’ll need to find a mortgage deal that works for you (a mortgage broker, like Habito, can help with this), gather the documents the lender needs to see, and complete the application paperwork.
As part of the application process, the lender will carry out:
- A valuation survey to check the property is worth what you’re paying for it
- Affordability checks to confirm you can afford the mortgage payments
- Credit checks to review your credit history and how you’ve handled debt in the past
If the lender accepts your application, you’ll get a formal mortgage offer, and you can get on with buying your new home.
Should you get a low deposit mortgage? Pros and cons
Is a low deposit mortgage the way to go? Let’s take a look at some of the potential benefits and downsides:
- You can buy a home sooner. You don’t have to spend as long saving up for a deposit so that you can buy a property more quickly.
- Becoming a homeowner is more achievable. If building up a big deposit isn’t an option for you, a low deposit mortgage can help you buy more easily.
Plus, with the mortgage guarantee scheme, you can:
- Avoid paying for a mortgage indemnity guarantee (MIG). This is a kind of insurance policy that some lenders require you to pay for before they give you a low deposit mortgage. It’s designed to protect them if you can’t keep up with your mortgage payments, and it can be an extra, expensive cost to factor into your homebuying budget. But, happily, if you get a mortgage under the mortgage guarantee scheme, your lender can’t ask you to cough up for an MIG.
- Your interest rate will likely be higher. As lenders consider low deposit mortgages riskier, they’ll usually charge higher interest rates to compensate for that. Meaning your monthly payments will be more expensive. It can be worth saving longer for a bigger deposit to get a cheaper mortgage deal.
- There are fewer mortgage deals to choose from. Not all lenders offer low deposit mortgages, so your choice will be more restricted. That said, the government’s mortgage guarantee scheme has already increased the number of deals available, so this downside isn’t as significant as before.
- There’s a risk of negative equity. With a small deposit and a big mortgage, you run a greater risk of getting into negative equity. That’s where the value of your property falls, and you end up with a mortgage loan worth more than your home.
Being in negative equity makes it more difficult for you to move, as the money you’d get from selling your current home wouldn’t be enough to clear your mortgage. But, if you’re planning on staying in your home for many years, this isn’t so much of an issue. There’s plenty of time for you to pay off more of your loan and for house prices to rise again.
Finding the right low deposit mortgage
If you’ve compared a few low deposit mortgages and you’re still not sure which way to go, our mortgage advisers at Habito can help you find the perfect deal for your situation. And it’s free!
Why not chat with us today?