Mortgages: Why putting up only a small deposit can prove a bad move for home buyers

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You are struggling to find a deposit towards the mortgage. The lender tells you not to worry, there will simply be a Mortgage Indemnity Guarantee added to the total loan. It sounds acceptable - but is it?

Hundreds of thousand of first-time buyers are bombarded daily with stories suggesting that the housing market is moving relentlessly upwards.

Many would-be homeowners feel that unless they join in the scramble, they won't be able to find an affordable house. Saving for a deposit in such circumstances is difficult, if not impossible. Which is where mortgage indemnity guarantees (MIGs) come in.

MIGs are a form of insurance, protecting when an enforced sale takes place of the property on which the money has been lent. Lenders use the MIG premium to take out a policy with a separate insurer.

If the borrower defaults on the mortgage and the house is repossessed, the lender claims back from the insurer any part of the difference between the amount it lent out and the finale resale price of the property.

Except that you pay the one-off premium on behalf of the lender. Meanwhile, even after you lose your home, the insurer can chase you for the money it paid to the lender.

Lenders argue, that the biggest risk of the MIG being called on in the event of repossession is when the margin between the initial deposit and the amount lent is lowest. As a result, the amount of MIG payable escalates rapidly the smaller the deposit.

For example, research by Your Mortgage, the monthly magazine, shows almost no lenders charge a MIG on a loan worth 75 per cent of the property. On a pounds 60,000 home with an 80 per cent loan, Woolwich charges pounds 156 and Direct Line levies a MIG of pounds 307. By the time your loan is 95 per cent of the pounds 60,000 value, Woolwich charges pounds 1,038.

Other lenders impose far smaller MIG penalties. Barclays Mortgages charges nothing on 80 per cent of loan-to-value (LTV), pounds 187.20 for 85 per cent LTV and pounds 795 for an LTV of 95 per cent. Britannia, by contrast, levies a punishing pounds 1,200 for the same loan.

Adding the MIG to the total mortgage cost compounds the problem. At current interest rates of 8.45 per cent, that extra pounds 1,000 means an extra pounds 7 a month on the cost of an interest-only loan. Over 25 years, that comes to extra repayments of pounds 2,100.

Nick Deutsch, managing director at FirstMortgage, a telephone-based lender, says: "The choice of MIG comes rather a long way down the thought process of a borrower. Most look primarily at the interest rate and the redemption penalty. MIGs are third or fourth on the list."

He adds that some lenders price their mortgages to attract borrowers who have a substantial amount of equity to put into their new property. High MIGs are one way of discouraging applicants with small deposits.

He advises: "If you are buying a property, what you should ask is not only what are the arrangement fees, but also the MIG costs, since they are an integral part of total costs."

Ian Darby, marketing director at John Charcol, the UK's largest independent mortgage broker, adds: "Unfortunately, most lenders will use a `sub-MIG' example when they give typical headline mortgage examples.

"Shopping around can provide different MIG charges. Some start at 70, 80, or 90 per cent. The way to minimise it is to use some lenders who don't apply it, or do so at higher levels."

C&G and Bank of Ireland Mortgage Services and the tiny Hinckley and Rugby Building Society, for example, charge no MIG at all, even on 100 per cent loans.

"Another thing to remember is that it is done in tiers, rising substantially for each 5 per cent. Some people might ask for a 90 per cent loan, but you can save an enormous amount by going for 89 per cent," Mr Darby adds. "What we offer is a `top-up' scheme, which is MIG-free. We choose the lender with the best interest rate on the market and borrow 75 per cent, then add a top-up loan from Norwich Union. To be honest it's a sprat to catch a mackerel because the company wants the insurance business, but it is often a good deal.

"Finally, some lenders are offering refunds on MIG fees to people who move home after a few years. Our advice is to always ask if some of the MIG will be paid back to you in the event of moving - after all, your premium should cover you for 25 years. Or get a discount on the new MIG. NatWest, for example, offers a discount on new MIGs for existing customers."

The Independent is offering a free 27-page Guide to Mortgages, written by Nic Cicutti, the newspaper's personal finance editor. The guide, sponsored by Barclays Mortgages, is available free by calling 0800 585691. Or fill in the coupon on page 4.


Cost of MIG on an 85 per cent loan

Bank of Scotland Mortgages Direct ZERO

C&G Lloyds ZERO

Hinckley & Rugby Building Society ZERO

Cambridge Building Society pounds 136.80

Cost of MIG on a 90 per cent loan

C&G Lloyds ZERO

Hinckley & Rugby ZERO

Direct Line pounds 347.96

Midland Bank pounds 354.00

Cost of MIG on a 95 per cent loan

C&G Lloyds ZERO

Hinckle & Rugby Buildig Society ZERO

Chorley & District Building Society pounds 630.00

Chesham Building Society pounds 675.00

Cost of MIG on a 100 per cent loan

Bank of Ireland Mortgage Services ZERO

Legal & General ZERO

Century Building Society pounds 850.00

Halifax pounds 1,087.50

Source: Your Mortgage