Tread Carefully with 5% Mortgages: A Guide for Homebuyers

In recent times, the real estate market has experienced a surge in demand, resulting in soaring prices. Factors such as the extended stamp duty holiday, the introduction of 95 percent mortgage schemes, and increased savings due to lockdown have created a bustling market that shows no signs of slowing down.

However, this frenzied atmosphere has led some inexperienced buyers to make costly mistakes. Gazumping, where buyers are outbid at the last minute, has reached unprecedented levels, causing many to stretch their budgets to secure a property.

For struggling buyers, the newly introduced 95 percent mortgages may seem like a lifeline for their limited budgets and a chance to step onto the property ladder. But buyers need to exercise caution, as this seemingly beneficial product could lead to long-term challenges in exchange for short-term gains.

Understanding 95 percent Mortgages

Purchasing a property with a 5 percent deposit certainly makes it easier for buyers with limited immediate capital to make a purchase. In a highly active market with escalating prices, this scheme provides an accessible option for those already stretching their budgets.

However, there’s more to this than meets the eye. Sellers are often aware of the potential savings made through these mortgages and may increase their asking prices accordingly. Coupled with the high prevalence of gazumping in an inflated market, it becomes challenging for buyers to determine if they are getting a fair deal. Buyers who can only afford these smaller deposits are particularly vulnerable to being repeatedly outbid by higher offers just outside their budget. Even a slight increase in their offer price represents a much larger portion of a 5 percent buyer’s funds compared to those with traditional 20 percent deposits or higher.

Additionally, it’s crucial to note that lenders typically charge higher interest rates on lower deposit deals. Many first-time buyers may be unaware of the significance of interest rates or simply have no other option. In this inflated market, those purchasing with 5 percent mortgages are likely to pay significantly more in interest compared to a scenario where prices were slightly lower. Furthermore, 5 percent buyers may spend a longer time paying off their mortgages than those with larger deposits. While this may seem obvious, it’s surprising how often buyers overlook this factor and fail to consider how the additional five to ten years of debt could impact their lives.

By carefully considering these factors, homebuyers can make more informed decisions when navigating the real estate market, avoiding potential pitfalls associated with 5 percent mortgages.

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 percent 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 percent mortgages. With higher interest rates and a lower starting position than the average buyer, it will be very difficult for 5 percent 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 percent 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 percent mortgages may provide a vital step up for those looking to get onto the ladder, but buyers should tread carefully and make a judgment 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.