Mortgage Guarantee Scheme: How the New 5% Deposit Programme Works
The new mortgage guarantee scheme, unrelated to Help to Buy, is expected to encourage more lenders to offer mortgages to buyers with a deposit of as little as 5%. The scheme should make it easier to purchase a home with a low deposit mortgage.
If you are a first-time buyer struggling to build up a sizeable deposit or an existing homeowner with little equity in your property your mortgage options could be about to widen. This is because the government announced a new mortgage guarantee scheme in the 2021 Budget that is expected to make low deposit mortgages more readily available when it is launched in April.
But how does it work? And who can qualify for the scheme?
What is the mortgage guarantee scheme?
The new mortgage guarantee scheme has been designed to encourage more lenders to offer mortgages to buyers with a deposit of as little as 5%, with the government effectively promising to cover the losses for a lender if the mortgage goes wrong.
Building a decent deposit is one of the biggest challenges home buyers face, and this has only become more difficult as house price growth has rocketed over the last year. According to the most recent house price index from Nationwide Building Society, the average house price in the UK in January was £231,061 ‒ the highest on record ‒ having grown by 6.9% over the previous 12 months.
This has been accompanied by a fall in the number of mortgages offered by lenders at and above 90% loan-to-value (LTV) over the last year, as they have adopted a more cautious approach due to the coronavirus pandemic.
The scheme should mean that more borrowers will be able to get up to a 95% LTV mortgage, leaving the remaining 5% of the loan to be paid by the borrower in the form of a deposit.
This new program is different from the mortgage guarantee scheme that expired in 2016 as part of the Help to Buy programme.
When does the mortgage guarantee scheme start?
The government hasn’t provided an exact start date for the scheme yet, merely confirming that it will launch in April 2021.
It will then run until 31 December 2022.
How does the mortgage guarantee scheme work?
One of the big reasons lenders have been less willing to take on borrowers with only a small deposit is that they view these loans as being riskier — a 5% deposit is low compared to more traditional 10% to 20% or larger deposits.
The guarantee scheme aims to remove some of that risk to lenders, as the government will compensate them for a portion of the losses they incur if you fall behind on your repayments to the point that the lender has to repossess the property.
The idea is that by reducing this risk, lenders will be more comfortable offering low deposit mortgages.
Importantly, there is no direct benefit to you as a borrower from the guarantee scheme. So if you fall behind on your repayments, the lender can still repossess the property. It’s simply that a large chunk of the money the lender loses as a result of having to repossess the property is guaranteed by the government.
It’s worth highlighting that a similar scheme was launched by the then-government back in 2013, and this new guarantee scheme works in much the same way.
Who can qualify for the mortgage guarantee scheme?
The mortgage guarantee scheme isn’t being limited to first-time buyers. As a result, even if you are on the housing ladder but struggling to raise the funds to move on to a new, bigger home then you may be able to take advantage of a mortgage offered under the terms of the scheme to snap up your new home.
However, the scheme has been designed specifically to help people looking to purchase a home they intend to live in, so there won’t be any buy-to-let mortgages available under the scheme.
What sort of mortgages will be offered through the mortgage guarantee scheme?
Mortgages offered under the scheme can be used for home purchases worth up to £600,000, and will be available at between 91% and 95% LTV. In other words, you will still need a deposit of between 5% and 9%.
The guarantee scheme will also only apply to capital repayment mortgages, which means that your monthly repayments will go toward paying both the interest and the balance of the loan. So you can’t get an interest-only mortgage through the scheme.
It’s up to the individual lenders offering loans through the scheme to design exactly how those mortgages will look. However, any lender participating in the scheme must offer a five-year fixed rate under the guarantee. The government said that this is so that borrowers with small deposits can also enjoy the security of predictable payments for a longer period rather than simply a couple of years through a two-year fixed rate.
» MORE: How a fixed-rate mortgage works
The pros and cons of a low deposit mortgage
Mortgages that are offered at high LTVs are something of a lifesaver for many borrowers. It’s easier for a borrower to save for a deposit of 10% compared to a 25% deposit, for example, enabling these would-be homebuyers to proceed with their purchasing plans and either get onto the ladder, or move up a rung to a new property.
There are some downsides to consider though. For example, mortgages offered to borrowers with small deposits tend to come with higher interest rates, which means the size of your monthly repayment will be bigger than it would be if you were eligible for a lower rate by making a larger deposit.
You are also at greater risk of falling into negative equity. This is when the size of your mortgage is more than the value of your property and can be a real problem. For example, when your initial fixed rate deal comes to an end you move onto your lender’s standard variable rate (SVR) which is always more costly. However, you won’t be able to remortgage to a cheaper deal if you are in negative equity.
Similarly, moving house is difficult as the sum raised from the sale won’t be enough to pay off your outstanding mortgage, let alone provide you with a deposit for the next property you want to buy.
If you buy a property with a larger deposit ‒ say 20% ‒ then even if the value of the property falls, it is unlikely to drop so sharply that you end up in negative equity. But if you buy a property with a 5% deposit, then the value of your home does not need to fall by much to leave you in negative equity.
How do I find a participating lender?
A host of lenders have confirmed they will be offering deals under the scheme already.
These include Barclays, HSBC, Lloyds, NatWest, Santander and Virgin Money.
When the mortgages offered through the scheme eventually go live, you will be able to apply for them directly with the lender. Alternatively, you might prefer to make use of the services of a mortgage broker.
These independent advisers can direct you towards the most appropriate mortgage for a borrower in your circumstances, as well as the lenders that are most likely to accept your application.
» MORE: Do I need a mortgage advisor?
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John Fitzsimons has been writing about finance since 2007. He is the former editor of Mortgage Solutions and loveMONEY and his work has appeared in The Sunday Times, The Mirror, The Sun and Forbes. Read more