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In recent years the opportunities for first-time buyers to get on the property ladder with small deposits have increased as more lenders have returned to this market, but the costs of doing so are disproportionately high compared to buying with a larger deposit as our calculations show.
Many people will not have a choice, but if there is any way that you can muster up a 15 per cent deposit instead of just 10 per cent, there are considerable savings to be made.
If you haven’t already exhausted the Bank of Mum and Dad, it is certainly worth seeing if they can lend you the extra 5 per cent. You could comfortably pay your parents more than they would earn on the top-paying savings account and still be much better off than you would by taking out a 90 per cent loan-to-value deal.
One of the reasons for this pricing anomaly is that lenders are required by the regulator to hold more capital to protect themselves against riskier high loan-to-value mortgages and they inevitably pass on the extra cost to the borrower.
Taking out a personal loan to fund part of a deposit could actually be cheaper than using a bigger mortgage. Despite the higher rates charged on personal loans compared to mortgages, the shorter term of the personal loan could mean that over time it is a less expensive option.
Let’s take the example of a borrower who is buying a house worth £300,000 with a 10 per cent deposit (£30,000 in this case).
The borrower could take out a 90 per cent loan-to-value mortgage for £270,000 from Santander fixed for two years at 2.21 per cent with a £995 fee.
That would result in monthly payments of £1,172.
Alternatively, the borrower might consider an 85 per cent loan-to-value mortgage for £255,000, also from Santander, at a rate of 1.59 per cent with the same fee.
This would result in monthly payments of £1,030.
In this case they would need to somehow find a further £15,000
The buyer might consider taking out a personal loan to be repaid over a ten-year term at a rate of 5.3 per cent from Tesco Bank.
This would result in monthly payments of £160 for the loan. The monthly total including mortgage repayments would be £1,190.
In these examples the monthly payments for the 85 per cent deal are £18 per month higher, but this borrower would be paying off around £113.41 extra in capital each month.
After two years they would have paid off £2,737 more capital than the borrower who took out a 90 per cent LTV mortgage and at the end of ten years the personal loan would be completely paid off.
By this point, the borrower who took out the 85 per cent deal will be in a much better position to qualify for a cheap mortgage rate as their LTV position will have improved significantly as they have built up equity in their home.