By Ray Harriot, co-founder and CEO, Reliable Property Group
During the busiest year for house purchases since 2008 we’ve seen frenzied demand lead to skyrocketing prices. The combination of the extended stamp duty holiday, the introduction of 95 per cent mortgage schemes and household savings bulging from months of lockdown has produced an incredibly busy market that shows little sign of slowing.
This frenzy has led to some inexperienced buyers making mistakes that will cost them in the long term. Levels of gazumping are at an all time high and the anxiety of being outbid at the last minute has pushed many into the upper reaches of their budget.
For these struggling buyers, the recently introduced 95 per cent mortgages in particular may appear to be welcome relief for tight budgets and much-needed support in securing a foothold on the property ladder. However, buyer beware – depending on your circumstances, this new product could offer long term headaches in exchange for a short term gain.
Assessing 95 per cent mortgages
Buying with a 5 per cent deposit does make it significantly easier for buyers with low immediate capital to secure a purchase. In such an active market where prices are at an all time high with minimal signs of slowing down, the scheme provides an accessible option for those already stretching their budgets.
However, there’s more to this than meets the eye. In many cases, sellers are aware of the potential savings being made, reportedly adding the equivalent sums onto their asking price. Combined with the high levels of gazumping in the already inflated market, it is extremely difficult for buyers to tell if they’re getting a fair deal. Buyers who can only afford these lower deposits are particularly at risk of being repeatedly pushed out of deals by higher bids just outside their budget. Even adding a small amount to their offer price will equate to a far greater proportion of a 5 per cent buyer’s funds compared to those buyers with traditional 20 per cent deposits or higher.
Alongside this it is important to note that lenders are charging higher interest rates on these lower deposit deals. Many first time buyers will either not be aware of the importance of interest rates or will have no other option. In this inflated market, those buying with 5 per cent mortgages today will likely pay off a far greater amount of interest than they would if prices were even slightly lower. Moreover, it is likely that 5 per cent buyers will spend longer paying off their mortgage than other deposit holders. While this may sound like an obvious point, it is surprising how few buyers take this into account – and consider how that additional five to ten years of debt may impact their lives.
How to tell if they’re right for you
The news isn’t all bad. Those buyers who do their due diligence and carefully consider their own financial situation may be best situated to benefit from the lower deposit schemes.
5 per cent mortgages are particularly well-suited to those looking to stay in their new property long term. If you can afford the monthly payments and do not intend to move again, at least for the foreseeable future, it should not necessarily matter how much equity you build up in a property.
However, those intending to move in the next few years and potentially see this purchase as an investment will put themselves at risk with 5 per cent mortgages. With higher interest rates and a lower starting position than the average buyer, it will be very difficult for 5 per cent buyers to build a significant amount of equity within a two or five year fixed rate time limit – and even worse, they could fall into negative equity if the market experiences even a small downturn.
Planning further ahead will now be key for those considering a 95 per cent mortgage. The inflated prices will drop at some point in the future, meaning there may be a longer wait before they can sell their new property at a profit. While it is all too easy to find yourself caught up in the current frenzy, chasing rising prices and going over asking price to avoid being gazumped, you must ask yourself if the property will suit your needs for the next ten years, rather than just the next two.
Another due diligence exercise buyers may want to consider is a back-dated valuation. While everyone is aware of the inflated prices, a valuation from the start of 2020 will show if the increase in price is in line with the previous growth in the area, and just how much more it will cost to buy right now. This can indicate that in the case of a market correction, properties that have inflated more have further to fall and are riskier to buy at their peak.
95 per cent mortgages may provide a vital step up for those looking to get onto the ladder, but buyers should tread carefully and make a judgement based on their own individual situation. Taking the time to fully understand your own current situation and future plans, as well as the state of the market and how this may change soon, will pay dividends later.
