You pay up, we get protected. OK?

James Hipwell examines a guarantee that can give the home-buyer an unpleasant surprise
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The Independent Online
The first time most borrowers come into contact with a mortgage indemnity guarantee (MIG) is when they are about to finalise their mortgage and move into their new home. And yet it could be the largest additional expense.

If you borrow 100 per cent of the value of your new home, you could be charged pounds 2,500 on a pounds 100,000 home, which would have gone a long way to redecorating it. So what is it, and why do you have to pay it?

The MIG is simply a form of cover provided by insurance companies that protects the lender against losses that may result if you fail to keep up the payments and the house is repossessed. Sadly, although the borrower has to pay the premium, he or she gets absolutely no protection whatsoever: the guarantee only protects the lender.

Moreover, if the lender makes a claim, the insurance company, through what is called the right of subrogation, is within its rights to knock at the borrower's door and demand back the money it has handed over to the lender. That is the legal position. In practice, insurance companies don't usually come calling since they presume that the repossession has resulted from a severe lack of money. But if they have the faintest suspicion that you might have the funds, they will take steps to recover what is owed.

The Building Societies Ombudsman, Brian Murphy, observes: "This is a doubly worrying problem because insurances are invariably triggered at a time when borrowers are already in financial trouble."

Worse, borrowers aren't even allowed to see copies of the policies, because even though they pay the premiums, they are not parties to them.

"I am increasingly concerned that most, if not all, societies are refusing to provide copies of these policies to the borrowers," says Mr Murphy. "The whole relationship between societies and their members is, or should be, based on trust and confidence."

First-time borrowers are usually the ones who are faced with paying MIGs, as they are more unlikely to have saved for a deposit. Older homes and larger loans may be charged even more.

The MIG may allow people to borrow more than the normal lending limit. A few institutions allow you to add it on to your mortgage; others let you pay it gradually; a few want it paid up front. So it is wise to find out right at the start how much it is going to cost and how you will be required to pay.

The only way to avoid a MIG is to have a deposit of at least 25 per cent of the property's value, or to arrange a loan with a lender that doesn't make a charge, such as the Cheltenham & Gloucester, which abolished its MIG charge more than a year ago.

Instead of charging you a MIG, some lenders have schemes for maximum advances, which are another form of risk-pricing. With these schemes, additional interest is charged on the whole advance for the first year, reflecting the additional risk that the society faces as a result of lending above 75 per cent of the property's valuation.

Nationwide Building Society has such a scheme. It is keen to point out that it is not an insurance, and it does not indemnify the borrower or the society against any future losses. "The society reserves the right to pursue borrowers for any losses sustained by the society," it adds.

Nationwide's scheme for maximum advances does offer some advantages over other lenders' MIG policies. The cost is spread over the first year's monthly payments, which means that the customer doesn't have to pay the whole amount at the outset of the mortgage. Also, as the charge is in the form of additional interest in the first year, borrowers can receive tax relief on the payments, up to the normal Miras limit. That said, a 95 per cent loan on an pounds 80,000 valuation would mean Nationwide borrowers having to cough up an extra pounds 95.34 a month in the first year of the loan.

A survey in the February issue of Your Mortgage magazine reveals that Birmingham Midshires, now a Top 10 building society with assets of around pounds 5bn, is one of the three most expensive MIG chargers for this size of loan and valuation, demanding pounds 1,600 from hard-pressed homebuyers.

Apart from the C&G, the survey identifies several other "winners". The Bank of Scotland offers competitive MIG rates, charging only pounds 477 and pounds 715 on a 90 per cent and 95 per cent loan respectively. Midland Bank, Yorkshire Bank and First Direct, as well as Cambridge, Shepshed, West Cumbria and Standard building societies, levy "competitive" MIGs on most of their loans.

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