Why homebuyers should be wary of the new crop of 95% mortgages

The government has rolled out a new state-backed 95% loan-to-value mortgage scheme. But there are several drawbacks.

Estate Agent displaying a very small living room
If your estate agent looks thrilled, stay put
(Image credit: © Getty Images)

The government has rolled out its latest weapon in the battle to turn Generation Rent into Generation Buy. A new state-backed mortgage scheme, launched in mid-April, aims to help prospective home buyers with 5% deposits. First-time buyers and existing homeowners who are moving are eligible, up to a purchase value of £600,000 (second home and buy-to-let acquisitions are excluded).The help takes the form of a guarantee to the lender: the state will step in for the portion of the loan over 80% if the buyer defaults.

The latest state subsidy for the housing market aims to address a shortage of 95% loan-to-value (LTV) options. Data from comparison site Moneyfacts shows that there were 391 such mortgages on the market in March 2020, but one year later the figure had plunged to just five; the arrival of Covid-19 caused lenders to batten down the hatches. That number is now back on the rise courtesy of the loan scheme.

So is it worth a look? The plan does not directly improve affordability. Buyers will still only be able to purchase properties worth 4.5 times their income in most cases, so the main beneficiaries will be those who are already earning enough to afford a property in their area, but who have been struggling to get together a big enough deposit. It won’t help if you live in a place where property prices are simply out of reach.

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The biggest drawback of higher loan-to-value mortgages is that they increase the risk of negative equity (when the value of a property falls below the outstanding mortgage balance). Many worry that the property market is already overheated.

With a 95% mortgage it takes “just a small fall in the value of the home” to tip a borrower into negative equity, says Shane Hickey in The Observer. That can make it hard to move. And securing a new fixed-rate mortgage when renewal time arrives can also be challenging.

Another problem, says Stephen Maunder on Which.co.uk, is that 95% mortgages are not attractively priced. Pre-pandemic, 95% two- and five-year fixed mortgages were going for less than 3%. A year later those rates are now closer to 4%, suggesting that lenders are still “sizing up the market”. That compares with rates of around 3% on the 90%-fix equivalents, which are still up by “more than 1%” since Covid-19 took hold.

Mortgage rates for those with small deposits are still “close to a three-year high”, adds Kate Palmer in The Sunday Times. Brokers report that up to 19 out of 20 applications for 95% mortgages are currently failing to get to the agreement-in-principle stage. That is due to tough credit-scoring and affordability criteria. To ensure a speedy approval get all the paperwork ready beforehand, including “three months of payslips and two years’ employment history for the self-employed”.

Given all the constraints, there has been no great “clamour” for the new loans. Many first-time house buyers are sitting out the current property-market frenzy. No wonder, says James Coney in the same paper. The housing market has “gone completely haywire”. When your estate agent looks this “delighted”, perhaps “you should stay put”.