Do I need a bigger deposit for a contractor mortgage?

One of the biggest myths in our industry is that deposits for contractor mortgages are greater than normal. Yes, homebuyers have an advantage if they can ‘put down’ more. But contractors are no more obliged to find bigger deposits than permanent workers.

In this article, I’ll clarify:

• The minimum contractor mortgage deposit that lenders require
• Why the more you put down, the better off you’ll be in the long run

The minimum contractor mortgage deposit required

To qualify for the minimum-deposit contractor mortgage, you must find at least 5% of the home purchase price. So, if a property is on the market for £100,000, you’d need £5,000 to put down. That leaves a balance of 95% of the purchase price to borrow from the mortgage provider.

This is what a mortgage advertised as 95% LTV means. LTV is the loan-to-value ratio. In this example, the ratio is 95% borrowing to 5% deposit.

If you had a 10% deposit for a £100,000 home, the ration would be 90% LTV (90% borrowing versus 10% deposit). And, while 5% deposit mortgages for contractors are available, the better rates start to kick in at 10% deposit, and above.

Why are the better rates for bigger deposits?

There are two key reasons you should think about a bigger deposit:

1. You reduce the mortgage provider’s overall perception of risk of the deal
2. You’ve shown an aptitude to save more, which can help an underwriter see you as more responsible

Both of these are good things:

1. Risk of negative equity

One thing lenders are always conscious of when setting their rates is the possibility of negative equity. That’s when the value of the home on which the loan is secured falls below the outstanding mortgage on the property.

This would only become a problem to them if the homebuyer continually defaulted on their payments. To recover their losses, the bank would first repossess the property. They’d then try to sell it into the marketplace.

If the house were valued considerably lower than the outstanding mortgage balance, they’d lose money. Risk of negativity equity increases the lower a deposit a homebuyer puts down when they take out a mortgage.

If a buyer puts down 10% or 15% deposit, the chance of their home falling into negative equity greatly decreases. The property would have to lose a lot more physical value to take it below the outstanding mortgage amount. This is the main reason lenders offer better rates for bigger deposits.

2. Responsible borrowing

Lenders also like to see fiscal responsibility in potential mortgage borrowers. Part of that comes from the applicant’s credit history. But even someone who continually just earns enough to cover their bills can have a perfect credit score.

If an applicant has saved a decent deposit, that shows more responsibility. They either:

• Have a well-paying job that’s allowed them to save so much, or
• Have made sacrifices from their disposable income to save that deposit.

Either will help convince an underwriter that the applicant is good for the mortgage loan. They’ll also ensure that the lender is applying the due diligence that Responsible Lending guidelines dictate they’re duty-bound to uphold.

The hidden costs of buying a home

But what you don’t want to do is put so much down that you don’t have enough for the other costs of buying a home. There are all manner of factors you may not have budgeted for, especially if you’re a first-time buyer.

Stamp Duty Land Tax

Depending upon your new home’s value, you must build Stamp Duty into your budget. The current Stamp Duty rates are:

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You needn’t manually try to work out what SDLT you need to pay. Just enter the home’s value into our Stamp Duty calculator; it will do all the work for you.

Arrangement, survey and land registry fees

You may also have to pay an arrangement or lender’s fee. If you’re remortgaging, lenders often waive this charge to entice you to stay with them. However, it’s unusual for first-time buyer mortgages to be free of this fee.

The property itself must undergo a survey (unless it’s a remortgage). This is to ensure that the home is worth what you and the vendor say it is. The lender won’t stump up £250k for a home they don’t think is worth it.

Land registry fees also vary depending upon the price and scope of your new home. These may or may not be included in the other legal fees. When you appoint your solicitor, they’ll tell you how much they charge for the service, and any other costs you may face.

What a bigger deposit can do for you

Until you’ve seen and priced your property, it’s hard to gauge the exact amount of your up-front costs. This is another reason it’s important to have as much saved for a deposit as possible.

Here are a few more reasons that may tempt you to tighten your belt until you have a more sizeable deposit:

All mortgage lenders (or brokers) will assess your affordability before they check your application.

If you only have a small deposit, it may be that they more intensely scrutinise your income and outgoings.

Negative equity becomes less probable the larger the deposit you put down. If you only have 5% saved, there’s a greater chance of negative equity.

If you have 25% or more set aside, the market would have to almost collapse before the lender risked losing its money in the short term.

Bigger deposit = more lenders and better interest rates

The scope of lenders willing to offer a competitive contractor mortgage deal will increase if you have a larger deposit. Some of the most competitive deals begin at 15% deposit and upwards.

A competitive deal means a lower interest rate, so a lower monthly repayment. It also means you’ll pay less for your home over the mortgage term. It may even free up more of your disposable income to intermittently pay off chunks of your mortgage (if your deal allows).

To work out what your repayments might be, we have a dedicated repayment calculator.

For a competitive contractor mortgage, you should be aiming for a minimum deposit of 10-15%. Yes, you can get onto the property ladder with only 5%. But those mortgages will attract less competitive rates, costing you more in the long run. Save more today to save even more tomorrow.