If you’ve been paying attention to headlines in recent months, you may have seen a study published in FT Adviser about the recent difficulties facing potential home buyers. One of the main takeaways of the study was that almost half of first-time buyers had to delay their purchase last year due to the rise in deposit requirements.
The housing market enjoyed strong growth in 2021, partly due to the chancellor’s announcement of the Stamp Duty holiday, which reduced the amount of tax that many buyers would have to pay. However, the growth in house prices have meant that many people now need to save up for a larger deposit.
If you’ve been wondering why having a large mortgage deposit is so important, read on for everything you need to know.
When you take out a mortgage, you represent a risk to the lender
Buying a house is a major life milestone and is likely to be one of the biggest financial commitments that you’ll ever make.
According to figures from the Office for National Statistics (ONS), the average house price in the UK is now £251,000. This is a significant sum and unless you’re very lucky, it’s unlikely that you’ll be able to buy it with cash.
When you borrow money to buy a home, you represent a sizeable risk to the lender. If you’re unable to repay your loan, they may stand to lose a significant amount of money. Because of this, they will usually ask for several assurances from you, such as checking your credit and recent finances.
This is also where your deposit comes in. When you commit some of your own funds towards the purchase, it demonstrates to the lender that you’re invested in the transaction. And, the bigger the deposit you put down, the more likely a lender is to get back the money they lent you, even if you don’t keep up your repayments. This makes you less of a risk to them.
You may get more favourable interest rates with a larger deposit
One of the main factors which influences the size of your deposit is the loan-to-value ratio (LTV) of your mortgage.
As the name suggests, this ratio is essentially how much the lender is willing to loan to you, compared to the value of the asset. The obvious benefit of securing a high-LTV mortgage is that you would need a smaller deposit.
For example, if you were buying a home worth £200,000 with a 90% LTV mortgage then you would need a £20,000 deposit to secure it. If you had a 95% LTV mortgage, you would only need £10,000.
Many first-time buyers struggle to save up for a large deposit. According to Unbiased, the average LTV ratio for first-time buyers is 82%, compared to 71% for home movers.
While a smaller deposit it easier to save for, it’s worth noting that there are several good reasons to save up for a larger deposit, if you can afford to. The reason for this is obvious – the larger your deposit it, the smaller your loan will need to be.
This has two main benefits, the first of which is that since the loan is smaller, it will not accrue as much interest as a larger loan would over time.
Furthermore, by providing a larger deposit you’re demonstrating that you’re less of a risk to the lender, which can mean that they offer you much more competitive interest rates. This can save you a considerable amount of money in the long term.
Another benefit of saving up for a larger deposit is that you can reduce the risk of falling into negative equity. This is when the value of the property becomes less than the amount of money you still owe on your mortgage.
For example, say you wanted to buy a £250,000 house and so you take out a 90% LTV mortgage. This means the value of your mortgage is £225,000.
If the next day an unexpected market downturn caused the value of your home to fall by 15%, down to just £212,500, then you would owe more than the value of your home. This would put you into negative equity and could pose a significant problem when you came to move.
Such a significant fall might seem outlandish, particularly at a time when the housing market is experiencing strong growth, but such falls do happen. A notable example of this was the aftermath of the 2008 financial crisis, which left thousands of homeowners in negative equity as values fell sharply.
Saving up for a larger deposit can help you to avoid this prospect.
A Lifetime ISA can help you if you’re trying to save up for a deposit
If you’re struggling to afford a large enough deposit, or want to save for a larger one, one of the best ways to grow your wealth is with a Lifetime ISA (LISA). This is a savings account specifically aimed at helping young people afford their first home.
In the 2021/22 tax year, you can save up to £4,000 into a LISA and, like with other ISAs, the returns on your contributions are free from Income Tax and Capital Gains Tax. This can make it an easy and tax-efficient way to save.
Furthermore, the main benefit of this type of savings account is that the government will top up any money you deposit into it with a 25% bonus when you use it to buy a home. This means that if you save the full £4,000 for one year, you’ll receive an extra £1,000, bringing the total amount up to £5,000.
If you don’t use your LISA for a mortgage deposit, you can also use it to fund your retirement after the age of 60.
However, if you make withdrawals that aren’t related to buying your first home or retirement, you will have to pay a 25% charge. Furthermore, contributions into your Lifetime ISA count towards your annual ISA allowance of £20,000 so it’s important to bear this limit in mind when making contributions.
Saving up enough for a mortgage deposit can sometimes be challenging and so, if you’re struggling to do so, you may benefit from speaking to a mortgage broker. Working with a professional can help you to manage your wealth more effectively, making it easier to get onto the property ladder.
Get in touch
If you want to know more about how professional advice can help you to buy your first home, get in touch. Email email@example.com or call us at (0207) 808 4120 to find out more.
Your home may be repossessed if you do not keep up repayments on a mortgage or other loans secured on it.