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Spend & Save

Lenders cover themselves and cash in on borrowers

House buyers pay through the nose to ensure that mortgage companies don't lose, writes Andrew Bibby
Mortgage lenders are milking thousands of pounds in extra insurance premiums from British borrowers, who receive no benefit from the policies. The back-door charges levied by lenders, called mortgage indemnity guarantees, can vary by up to £1,000 between mortgages of equal size.

This means a borrower could end up paying almost £3,000 more than a neighbour living in an identical home in the same street over the lifetime of a mortgage.

For example, a borrower approaching Norwich and Peterborough or Lambeth building societies for a 95 per cent loan on a £60,000 house purchase is being asked to pay an indemnity of £1,200.

If the same person went to Yorkshire Bank, the charge would be just £450.

Millions of home owners pay through the nose for such guarantees, which are usually imposed whenever the amount being borrowed is 75 per cent or more of the property's valuation.

Yet they do not benefit from this controversial type of insurance, since the cover only protects lenders in cases where houses are repossessed and sold for a sum less than the outstanding loan.

Many borrowers are hardly aware of the extra charge; they assume it to be part of the overall mortgage.

Ironically, the contracts are usually worded in such a way that a dispossessed home buyer is still liable to the insurance company that provides the indemnity for any additional shortfall.

Amanda Davidson, a partner at the financial adviser Holden Meehan, said: "It's a bit of a cheek that such big premiums are being charged in the first place.

"As a borrower, you're paying for the lender's benefit, not your own. For prospective borrowers, this highlights the importance of not only checking a lender's headline interest rate, but also all the other hidden costs. Failure to do so can add several hundred pounds a year to borrowers' payments for up to 25 years."

The lenders' charging policies are exposed in this month's Your Mortgage magazine.

An extra £1,000 indemnity guarantee payment, almost always added to the mortgage, would cost a borrower more than £2,750 over 25 years at an interest rate of 10 per cent, the average over the past 15 years.

Building societies benefit from the psychological pressures many home buyers feel at the moment of purchase.

Many borrowers are won over by a society's headline mortgage rate, and they often fail to spot all the charges and other hidden strings until it is too late. The extra costs are mentioned only when the would-be home-buyer is already sitting in the building society's offices.

Usually, although borrowers know that a charge may have to be paid, they do not know the exact amount until their prospective home has already been valued and a formal mortgage offer is made. This is because the indemnity is based on the percentage of the home's valuation, which is only known when the valuer's report comes in. By then, it often seems too late to back out.

The societies make money out of indemnity guarantees by pocketing at least 30 per cent commission for arranging them.

In addition, some, such as Yorkshire Building Society, are now bypassing the insurance companies and setting up their own subsidiaries to handle the business. This means they can achieve huge cost savings. However, Yorkshire's premiums - which stand at £1,020 - are among the highest charged and have remained at their previous exorbitant levels.

The unpopularity of mortgage indemnity guarantee payments has already led some lenders, including Cheltenham & Gloucester Building Society, to scrap the charge.

The C&G abolished them last November, arguing that customers should not be asked to pay the lender's insurance premiums. Yet most societies continue to levy the premium and willingly admit that they make significant profits from doing so.

Ken Hughes, deputy general manager of Norwich and Peterborough, said: "We do load the premiums ourselves, but they are not as high as in the olden days." He declined to give details.

Lambeth Building Society said that it took a 30 per cent standard commission offered by its two insurers, Legal & General and Norwich Union.

"It has always been paid to societies. A lot of societies regard it as just another source of income," said Barry Tibbatts, Lambeth's insurance manager.

Mr Tibbatts added that the Lambeth chose to hold a third of this commission in reserve against possible losses.

Banks tend to charge lower mortgage indemnity charges, because of a quirk in regulatory rules affecting their lending policies.

Yorkshire Bank, for example, says that it does not underwrite its mortgage risks externally. Its relatively low charge is not paid to insurers but is simply an an acknowledgement of the higher risk involved.

While lenders usually begin to charge indemnity guarantee premiums when an advance of more than 75 per cent is sought, some impose them only on a loan-to-value above 80 per cent. This reduces the cost.

Among lenders imposing smaller charges are the Barnsley and Marsden building societies, as well as Barclays, Midland, Lloyds, Yorkshire Bank and Bank of Scotland.

In contrast, Norwich and Peterborough and the Lambeth demand an indemnity charge above 70 per cent of loan to value. Because a higher fraction of the mortgage advance is subject to this surcharge, borrowers pay more as a result.