The gap between what a first-time buyer (FTB) may be able to borrow on a conventional mortgage and the price of a typical property can seem insurmountable, but there are a number of ways in which they can still get onto the property ladder.
With the average price of a residential property in London now £219,000 and the average starting salary of a graduate just £20,000, a growing number of young professionals are finding that conventional mortgages which lend 3.5 times income fall far short of their requirements. While some lenders will stretch these income multiples, notably the Royal Bank of Scotland, which will lend up to five times income for some professional applicants and Halifax which will go as far as six, the average graduate FTB would need a multiple of about seven times their income to cover the cost of a typical £150,000 one bedroom London flat. This is excluding the cost of legal fees, stamp duty, and furnishings.
Lenders have worked out that the assumed risk profile of some graduates means their earnings will greatly accelerate over the period of the loan, so the mortgage can be structured in such a way that it will allow them to overpay in subsequent years. This is why lenders seem more willing to let professionals, such as doctors, dentists, solicitors and accountants, take their borrowings to well above the 100% level.
Of course there are concerns about such large loans, especially as house price inflation slows. Those buying properties in London may remember the 1980s when thousands were landed with negative equity on their property and, with a 100% mortgage, just a 5% fall in value could begin to cause problems. Few experts, however, are expecting a return to 1980s style double-digit interest rates.
However, for many graduates low savings in the early part of their career means that a 100% mortgage, where no deposit is required to buy the property, may be their only option if they wish to get onto the property ladder. This type of loan is particularly attractive to graduates as they may also want to put other debts, such as credit card, onto a lower interest rate. A recent survey from Barclays showed that graduates left university with average debt balances of £11,000 in 2002, a 17% increase on 2001. Average credit card debts have increased from £760 to £903.
Some lenders have even built certain features into their products to help young graduates who may already be in debt. Debt owed to the Student Loans Company makes up the vast majority of graduate debt. As it can be paid back over the long term, some lenders, such as Scottish Widows, say graduates do not have to deduct it from their income. Only credit card debt is viewed as a significant problem.
For those who can find a deposit, Standard Life and Intelligent Finance, can lend up to four times joint income on an affordability basis to 95% loan to value. But rather than calculating the amount they are willing to lend as a multiple of income, the lenders may designate up to 40% of the applicant’s income to be used for credit purposes including outstanding non-mortgage debt. With interest rates at historic lows the amount they can lend on affordability has shot up. Ray Boulger, senior technical manager at Charcoal, says the approach is no more risky than using an income multiple. Boulger says: ‘In many ways it makes more sense because it takes into account actual circumstances. The bottom line is that nobody goes into a mortgage with the intention of not paying. So when people cannot pay their mortgage it is because something has happened to change their circumstances. Unless we get a sharp rise in interest rates, which does not look likely, you are probably looking at a change in family circumstances such as a relationship breakdown or a redundancy. Whether you have a 95% or a 100% mortgage you could still have a problem.’
One pitfall to be aware of with 100% plus mortgages can be the inclusion of a mortgage indemnity guarantee (MIG), which can cost 3% of the loan. However, this is not added to all 100% mortgages and Northern Rock, Scottish Widows and Mortgage Express all offer MIG-free 100% loans.
But while there are an increasing number of products available which allow the applicant to borrow over 100% of the value of the property, first time buying is fast becoming a family affair. With such high house prices, a guarantor mortgage may be the only way young graduates who are not going into a professional career can get on the housing ladder.
Guarantor mortgages, where parents act as guarantors, could be the quickest way for many young graduates to make a break from renting. This type of mortgage can mean there is no technical barrier on the income multiple of the graduate’s income. Provided a parent is willing to act as guarantor, a graduate could do a poorly paid job and be able to secure a loan. Scottish Widows, Newcastle Building Society and Northern Rock offer mortgages that allow parents to step in to guarantee the shortfall between what their children can borrow in their own right and the cost of the property. Previously the parent would have needed to have enough spare income to cover the entire cost of the mortgage, irrespective of the applicant’s own income.
While Newcastle Building Society’s 100% guarantor mortgage is only available to those in a limited number of professions such as lawyers and doctors, the Scottish Widows graduate mortgage is available to anyone within seven years of their graduation date. With a Scottish Widows graduate mortgage, for example, a newly qualified accountant, aged 23, earning £20,000 per annum, would be able to take out a mortgage on a property worth £150,000.
As with a traditional mortgage the applicant would be able to borrow at least 3.5 times their income, which in this example would be £70,000, but by using the graduate mortgage, the applicant would be able to secure an additional £80,000 if a parent was willing to act as guarantor for the additional funds. The lender says it considers the guarantors’ overall capacity to help service the mortgage if required, including their income, assets and existing commitments. By combining a guarantor element with a 100% loan-to-value plus element, the Scottish Widows graduate mortgage allows the buyer to borrow a maximum of 102% of the value of the property leaving them with an additional 2%.
Gordon Bowden, business development director at Scottish Widows, explains: ‘Getting someone on the property ladder is a very positive thing from a social perspective, and is seen as a better alternative to paying rent and putting money down the drain. Many graduates will not have any savings because they will have battled to get their student debt under control and get a job. So the extra 2% could help to buy furniture as well as to cover stamp duty and the legal fees involved.’
The extra borrowing can give some leeway, not just for furnishings and stamp duty, but to help those who are self-employed or looking to buy their first business. It also takes into account the bidding wars that have occurred in recent years for city centre property, allowing the buyer to make an offer above the valuation price.
One further point is that if these mortgages are taken out before the borrower has graduated it becomes a ‘guarantor mortgage for students’ and they can almost be seen as buy-to-let mortgages through the back door. As the borrower is likely to have little or no income of their own, they usually pay the mortgage by renting rooms to friends. Using a 95% guarantor mortgage the guarantor would need less capital than with a 75% buy-to-let mortgage. But for students the guarantor route is still less widespread.
David Hollingworth, mortgage specialist at London & Country, says: ‘Often it can seem that the most cost-effective way of doing it is to get friends in to pay the mortgage and get some capital growth at the end of it. The parents would need a bigger deposit using buy to let compared with a guarantor mortgage, but they would not have to cover their own mortgage as well as the buy-to-let mortgage on income. Unlike a guarantor mortgage the lender would consider how much rent would come in.’
First time buyers underpin the whole housing market, snapping up the properties of those looking to sell and move on. Lenders recognise their importance and have worked hard to create products to meet the needs in the market. For most borrowers, this new-found depth in the market means there is something suitable for their particular needs.