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Should I save for a 10% deposit if possible?

Should I save for a 10% deposit if possible?
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With the government’s Mortgage Guarantee Scheme set to launch in April, many UK homebuyers will be able to get on the housing ladder without the need for a 10% deposit. But is this a good idea? Let’s take a look at the pros and cons.

What is the impact of the Mortgage Guarantee Scheme?

The aim of the scheme is to encourage more lenders to provide 95% Loan-To-Value (LTV) mortgages for homes in England up to the value of £600,000.

The number of 95% LTV mortgages has fallen over the years. This is because lenders have wanted to reduce their exposure to the market, especially during times of economic hardship.

It is hoped that this scheme will encourage more first time buyers to get on the housing ladder. Using the scheme, those struggling to save the minimum 10% deposit required by most lenders will only have to save 5%.

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What are the pros and cons?

As such, there is no right or wrong answer. However, there are some pros and cons that are worth thinking about before signing on the dotted line.

The argument for using the Mortgage Guarantee Scheme

One of the biggest advantages of a smaller deposit is that it enables you to get on the housing ladder quicker.

The time taken to save for a larger deposit is time that you won’t spend on the housing ladder. So you could miss out on any increase in the value of your home during this time.

All lenders participating in the scheme will offer mortgages with rates fixed for at least five years. So another advantage of using this scheme is that you will be able to create a household budget safe in the knowledge that your monthly mortgage repayments will be the same for at least five years.

You could set yourself a goal to improve your financial situation during the five year period. You could then be in a better position to apply for another mortgage at a better rate when the period ends.

The argument for a 10% deposit

Despite government help, the interest rates on 95% mortgages tend to be higher than those for 90% mortgages. You will also have a greater selection of mortgages to choose from, so you are more likely to get a better deal.

House prices do increase over the long term, but they do not increase in a linear fashion. Prices rise and fall depending on the general state of the economy. There is no guarantee that the price of your home after five years will be higher than the purchase price.

The problem with a smaller deposit is that you have less protection against any volatility in the general housing market. If there is a market crash, there is an increased risk that the value of your home will fall below the value of the mortgage. This leads to a situation known as negative equity.

Even if you don’t end up in negative equity, your ability to negotiate a better deal on your mortgage after five years could be dependent on the amount of equity you have in your home, or its value compared with the original mortgage amount.

Increasing the deposit will reduce the size of your mortgage and increase your chances of greater equity after a fixed period.

What about monthly repayments?

One of the most immediate arguments for a bigger deposit is that your monthly repayments will be reduced and the amount of interest you pay over time will be less.

Let’s consider a home worth £250,000 and two possible mortgages, with a 5% and 10% deposit respectively. Both mortgages are at an interest rate of 3.09% for 5 years and have a 30-year term.

  • If you pay a 5% deposit the monthly repayment will be £1,013, or £61,072 over 5 years.
  • If you pay a 10% deposit the monthly repayment will be £960 per month or £57,874 over 5 years.

So in this example, increasing the deposit by 5% results in a £3,198 saving over 5 years.

If you project the payments over a 30-year period, the interest you pay with a 10% deposit will be more than £180,000, but with a 5% deposit, this increases to £190,000.

So in the long term, you could end up paying an extra £10,000 in interest over a 30-year term with a 5% deposit.

Finally

There is a great deal to think about, but remember that this may be one of the biggest financial commitments you will ever make. Take your time and consider all of your options.

When you work out what you can afford, don’t forget to make allowances for the one-off costs, such as stamp duty, legal fees and mortgage fees.

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