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, you are at an advantage if you can ‘put more down’. But you’re no more obliged to than permanent workers are.

In this article, I’ll clarify:

• Why 100% mortgages have all but disappeared;
• The minimum contractor mortgage deposit required;
• Why the more you put down, the better off you’ll be in the long run.

Ready? Here we go.

What is (was?) a 100% Mortgage?

Before the 2007/08 credit crunch, homebuyers could borrow the full value of the property they were buying. Ergo, you could take out a 100% mortgage from any number of mortgage lenders.

If you saw a house for sale for £250k but had nothing set aside for a deposit, no matter. Provided you met the lender’s affordability calculation, you could borrow the full amount.

Remember (or realise, depending upon your age), the market was different in the run-up to 2007:

• House prices were rising on (what seemed like) a never-ending upward spiral;
• Homes were often sold before they even went up in the Estate Agent’s window;
• Property investment was ‘as safe houses’;
• Lenders had no recourse to worry about negative equity.

From the bank's perspective, if you defaulted on your mortgage repayments, so what? The lender could repossess your home after a while. Yet, because of the upward trajectory of house prices, they'd still make a tidy profit when putting it back on the market. There was little to no risk on their part.

How different the market is today…

Negative Equity – The Probability Factor

…as you can imagine, once house prices began to slump in global recession, lenders’ attitudes changed. It was almost overnight, as if someone flicked a switch.

100% mortgages disappeared. In fact, you were lucky if you could find a mortgage with a deposit of less than 20% on the High Street.

Why did lenders act so cagey? Well, negative equity became a real possibility after the bubble burst. Nay, it became a probability with low deposits and high loan-to-value mortgages.

House prices were plummeting. Not quite as fast (or as completely) as they’d risen. But falling fast enough to make the banks and building societies nervous.

In theory, if you only had a 5% deposit, by the time your sale completed, the property could already be in negative equity. No more 'safe bet' for the lenders. And a very real conundrum for the home buyer.

Then with Responsible Lending, lending criteria became as watertight as deposits were steep.

The Minimum Contractor Mortgage Deposit Required

You may think that banks were only thinking of themselves by increasing their deposits. But in hindsight, they also prevented would-be borrowers from becoming mortgage prisoners. Namely, homeowners who couldn't move because their mortgage balance was greater than the value of their home.

You’ll be pleased to know, lenders have moved on from their knee-jerk reactions to the crises. Albeit with the Government* and FCA accepting the gauntlet and leading the way.

Today, to qualify for the minimum security contractor mortgage, a deposit of 10% is what you need from most lenders. Of those lenders offering such favourable terms, they then contribute the other 90% of the buying price.

So, imagine your desired property is on the market for £280,000. You’d need to save at least £28,000 for the deposit, then borrow £252,000 from your mortgage lender.

Help to Buy (Equity Loan and Mortgage Guarantee)

*The Government, as alluded, blazed the trail back to 5% deposit mortgages for contractors. That was before the COVID-19 Pandemic. Post-COVID, lenders began introducing 5% and 10% deposit mortgages of their own.

The now-defunct Help to Buy scheme was introduced:

• to give everyone a chance to get onto the property ladder;
• breathe new life into the faltering housing market.

The range of Help-to-Buy mortgage products offered a surprising degree of choice. Catering for deposits between 5%-20%, there was a product to suit most purse strings.

But even with this choice, there were more cost-effective ways for contractors to buy a home. The larger the deposit, the lower the risk you are in a lender's eyes. That helps them offer lower interest rates if you can up your deposit into the next LTV bracket.

The hidden costs of buying a home

When you’re buying a home, there are all manner of costs you may not have budgeted for. Especially if you’re a first-time buyer.

Depending upon the value of the home you’re buying, you must build Stamp Duty into your budget. Normally, this starts at 1% and rises as you add more noughts to the price.

However, due to the current Stamp Duty Holiday, borrowing up to the first £500,000 attracts zero tax. Pressure is on the Government from all quarters to extend the holiday beyond the envisaged end date of March 31^st, 2021. Watch this space.

Arrangement, survey and land registry fees

You may also have to pay an arrangement or lender's fee. If you’re re-mortgaging, 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. This is to ensure that the house is worth what you and the vendor say it is. The lender is not going to stump up £250k for a house that’s worth half that.

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 difficult to gauge the exact amount of your up-front costs. This is just one reason why it's imperative to have as much set aside for your 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 scrutinise your income and outgoings that little bit harder.

Negative equity becomes less probable the larger the deposit you put down. If you have only 10%, there’s little room for market movement.

If you have 40% set aside, the market would have to almost collapse before the bank was in danger of losing its money.

The bigger the deposit, the more lenders and better interest rates you can access

The scope of lenders willing to process your application will increase if you have a larger deposit. Some of the most competitive deals begin at 15% deposit and upwards. Some lenders don’t offer 95%, or even 90% LTV mortgages at all.

The more competitive your deal, the lower your mortgage interest rate, the less your monthly repayment will be. You’ll also be paying that interest on a much smaller balance if you can find 20-25% deposit, compared to 5-10%.

To get an idea of the variation, we’ve arranged our best-buy contractor mortgages in easy look-up tables. You’ll also get an idea of the terms (fixed rate, duration, etc.) that go with our range.

But for a competitive contractor mortgage, deposits of 15-20% are what you should be aiming for as a minimum. Yes, you can get onto the property ladder with only 10%. But only with select lenders, and then at less competitive rates.