Back from the dead: The 125% loan

Nationwide offers above-value home loans to customers in negative equity but only at a cost. Chiara Cavaglieri reports

In a controversial move, Nationwide customers have seen the return of mortgages of over 100 per cent, allowing them once again to borrow more than the actual value of their new property. The building society is offering existing customers struggling with negative equity a mortgage with a loan-to-value (LTV) of up to 125 per cent to help them move house.

High loan-to-value lending has been labelled by many as a symptom of the excessive lending that helped bring about the credit crunch. Northern Rock, for instance, was lambasted for continuing to offer its 125 per cent Together mortgage even after the bank had been bailed out by the taxpayer. What's more, Nationwide's move seems at odds with politicians pushing for mortgages capped at 100 per cent LTV, or even lower; while in September, it is possible that the Financial Services Authority will move to ban high LTV mortgages. So what is Nationwide up to?

"I think the key point here is that this is nothing like the Northern Rock Together mortgage," says Ray Boulger, senior technical manager at broker John Charcol. He explains that an important distinction to make is that the Nationwide mortgages are for existing customers alone, and are not aimed at new customers desperate to get on to the property ladder.

In fact, many mortgage market watchers have reacted positively to the move and see it as a potential lifeline for those in negative equity who need to move house. After the property price crash, many homeowners have found themselves trapped and unable to move because their home loan is worth more than the value of their property. In fact, the Council of Mortgage Lenders reckons that over a million UK homeowners are in negative equity. "Is it worthwhile? I think, yes. Very few borrowers will qualify, but for some whose credit rating is high and are a good risk, and who need to move through job relocation or because of a growing family, this offers a way of breaking the stranglehold of their current negative equity," says Richard Morea, from mortgage broker London & Country.

While not necessarily an issue for those happy to stay in their home until prices have picked up, negative equity can make it impracticable to sell up and move. Homeowners wanting to relocate would first have to pay off the equity shortfall, then cough up for a deposit on the new property. But Nationwide's mortgage allows homeowners essentially to carry the negative equity over to the new property.

The mortgage will all be offered on a fixed-rate basis and will work by offering homeowners an initial loan of up to 95 per cent LTV, meaning they are still required to put down a 5 per cent deposit under the scheme. On top of this, there will be another 30 per cent maximum available as additional borrowing. "This is a very niche product, a rescue mortgage if you like, especially for those in negative equity," says Chris A'Court, senior manager at Nationwide Building Society.

As an example, take a homeowner with property worth £200,000 and a mortgage of £220,000. In this situation, there is negative equity of £20,000 and an LTV of 110 per cent. If this homeowner then wanted to buy property worth £250,000, Nationwide would offer a 95 per cent mortgage, meaning a £12,500 deposit would be required, but the negative equity could be carried over, leaving the new mortgage at £257,500, and an LTV of 103 per cent.

Despite the benefit for those desperate to move, there are still some careful considerations to be taken into account. First, these homeowners will have to pay a hefty price for the privilege. The main mortgage has a rate of either 6.73 per cent, fixed for three years, or 7.48 per cent, fixed for five years, with reservation fees of £995 on both. Then, for the additional "top-up" loan, rates will rise to 7.23 per cent on the three-year fix and 7.98 per cent on the five-year fix.

In the wake of the recession, lenders have tightened their lending criteria substantially and the most appealing rates have been offered only to customers with hefty deposits. But, with the Bank of England base rate at 0.5 per cent, paying interest of between 6 and 8 per cent will still seem steep.

Also, there is a danger that any significant movement in the property market will leave customers who decide to take the plunge paying through the nose if rates become more competitive. Despite a 2.6 per cent rise in May, the most recent house price survey from Halifax revealed house prices then fell by 0.5 per cent in June. However, overall, the declines of 2009 have been considerably less than those seen in 2008, with a 1.9 per cent fall in the second quarter of this year, the smallest fall since the first quarter of 2008.

"If prices start to rise quite quickly, the borrower could have equity but be locked into an uncompetitive fixed rate, but that's the gamble with all fixes," says Mr Morea. He also thinks customers would be wise to find out how much extra they need to find to qualify for a conventional mortgage elsewhere with possibly lower rates.

Beyond these dangers, there is a good chance that only a very select few will have access to the 125 per cent mortgage, leaving many desperate to move but still stuck in their homes. Nationwide explains that it is not anticipating great demand for the product and will be offering them only to borrowers "in a very specific circumstance, who need to move, perhaps because of a change of job, or to move near to family, but cannot".

There can be little doubt that Nationwide will have stringent criteria for those who can get their hands on a 125 per cent LTV deal. The building society is eager to emphasise that the product is very much a specialised product and anyone who would struggle will be unable to access the additional borrowing. "We're not relaxing the lending criteria and there will only be a very small number of people who may benefit from this particular type of product," says Mr A'Court.