Home Loans That End In Tears

By Cliff D'Arcy | 18 March 2005

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There are over 11½ million mortgage borrowers in the UK, owing a total of £882 billion, or almost £77,000 each.

Having seen homes repossessed during the course of my work in the early Nineties, I worry about all those happy British homeowners. As I explained in How To Cope With Financial Disasters, one single unfortunate event could put you at the mercy of your creditors.

For example, any one of accident, sickness, unemployment, financial mismanagement, business failure, divorce or relationship breakdown could lead to the loss of your home. Of course, you could buy insurance against the first three risks, known as ASU cover, but 99% of these policies offer pretty poor value for money.

However, some borrowers are more at risk than others. For example, I worry about borrowers with this "share to buy" mortgage. Another home loan that makes me nervous is Northern Rock's "Together" mortgage. Here's how it works:

• You can borrow up to 125% of the value of your home via a mortgage lasting between seven and 35 years.
• The first 95% is a secured mortgage. The remainder is an unsecured loan of up to £30,000, charged at the same interest rate as your mortgage (which ain't a great rate, to be honest!).
• The unsecured loan can be repaid over three to 35 years.
• You can choose a fixed or variable interest rate.

Here's a practical example:

You earn £40,000 a year and apply for a Together mortgage on a house worth £160,000. The most you can borrow is 95% of the property's value, which is £152,000. To pay off other unsecured debts, you opt for an unsecured loan of £25,000 and arrange a repayment mortgage over 25 years with a variable rate.

If you choose not to pay the £695 arrangement fee, you pay a higher interest rate. Here's how your monthly repayments would stack up:

*TAR = Total Amount Repayable

So, after three hundred monthly repayments, your £152k mortgage and £25k loan would have cost you a total of almost £359,000 with a fee and £367,500 without. In other words, by not handing over £695 upfront, you end up paying almost eight grand in extra interest. Yikes!

Now, let's look at these figures again. Despite a fairly low interest rate, your £25k loan, spread over 25 years, costs over £50k in both examples. That's a lot of extra interest, when a bog-standard unsecured loan over ten years from - guess who - Northern Rock would have only set you back a total of £32,641. This alternative would save you up to twenty grand and, what's more, at just 5.7% APR, it has a lower interest rate than the Together loan. Sure, your monthly repayments would be quite a bit higher, but the extra effort saves you a fortune!

Speaking of monthly repayments, they are eye-poppingly high. In example A, they're over £1,193 a month; for B, the figure is £1,221. If you rake in £40k a year, you'd take home roughly £2,400 a month. So, your Together repayments would gobble up half your income, which is far too rich for my blood. I'd hesitate to spend a third of my take-home pay on mortgage repayments, let alone more than half!

Of course, the above example shows the maximum that you could borrow, but I'm still amazed that Northern Rock would consider granting a loan with the following characteristics:

• 95% loan-to-value ratio;
• 3.8 times income (if you include the extra £25k, this rises to 4.4 times); and
• Monthly repayments of 51% of salary (for example A, this figure falls just short of 50%).

These figures make alarm bells ring loudly in my head!

Finally, if you do have hefty unsecured debts (other than what you owe to the Student Loan Company), please think twice about borrowing as much as you can to buy a home. As sure as eggs is eggs, you'll come a cropper at some point further down the line. I'd get out of debt and start saving first!

More: Find a happier home loan in our Mortgage centre | Visit our Get Out of Debt centre.