Every year, there are several hundreds of thousands of people who approach a lender with a sound credit history, can evidence months or even years of renting and are still rejected for a mortgage on account of not having a large enough deposit. It doesn’t have to be this way and I hope that our new prime minister will recognise this.
When these creditworthy individuals with evidence of a strong rental history approach lenders, they are often made to go through a lengthy exercise before being told that the interest on any mortgage they could afford would be substantially less than their rent, but if they haven’t a sufficient deposit to bridge the purchase then they are stymied. They do not have a large enough deposit; the lender doesn’t lend, and the applicant walks away crestfallen.
To cite an example: three years ago, a tenant of mine at Acre Properties (let’s call him Tenant A) had been with his bank for over 15 years and his credit history was immaculate. He was paying rent at a rate of £1,100 per month for about seven years, while depositing £300 per month into a savings account.
Let’s say that Tenant A’s income was £40,000 per annum and his bank could lend 4.5 times his gross salary, so they could offer him a mortgage of £180,000. He had a saving of just over £20,000 for a deposit, but studio flats in his area start at a price of £230,000. So, unless his family could help him bridge the £30,000 shortfall, he’d be unable to buy. They couldn’t help, so he didn’t get a mortgage and he is still renting with us to this day.
The Problem
At the time, Tenant A could be offered a £180,000 mortgage and the interest per month stood at £250. However, although Tenant A was saving £300 per month which was going into savings, and the bank could see that year after year he was able to afford £1,100 per month in rent (amounting to a total monthly outlay of £1,400), the bank’s maximum monthly offering was a meagre 17.86 per cent of what he clearly could afford to pay out when factoring in his deposit.
He could afford over five times the bank’s so-called maximum and was turned away. Tenant A knew that it was a ridiculous scenario, and so did the bank, but they had their hands tied by the rules.
The Solution
The bank is usually constrained by its Regulatory Authority, but let’s just say that if the borrowing could be on a fixed interest term of 2.5 per cent for five years, and we assume in the worst case that a person has no deposit then:
In Tenant A’s scenario, the value of the £230,000 studio flat divided by his £40,000 yearly gross salary means that he needs to borrow 5.75 times his gross income. Banks will not lend this amount at the moment.
So, the government could step in and indemnify the lender for 10 per cent of the value of the flat (£23,000) and Tenant A could pay for a policy to cover that amount in the event of a forced sale and the property sells for less than its purchase price of £230,000. The government and the taxpayer are then safe, it won’t cost either anything.
The Regulatory Authority is also in the clear, since the downside is covered by the government and the buyer’s insurance policy, leaving them sleeping soundly.
Further to this, a £230,000 loan at 2.5 per cent interest equals £479 per month in payments for the first five years while the fixed rate is in place. But based on the £1,400 per month that Tenant A could afford, there’s a spare £921 per month there. With 60 monthly payments of £921 for those five years on the fixed rate of interest, the £230,000 outstanding loan drops to £174,740 needing to be paid off, which is 75.97 per cent of the value of the original loan – just five years in.
Incredibly, this is a worst-case scenario assuming that Tenant A has no deposit. Obviously, people may have deposits of five or even 10 per cent, making their position after five years even more advantageous.
On a side note – of course this is not guaranteed – but if the property were to increase in value by five per cent per annum, then after five years it would be worth £293,544, meaning that a person who had no deposit no how an equity of approximately £120,000 in five years. Try saving that amount of money in that amount of time!
Who wouldn’t want an equity of £120,000 from nothing? And even if the equity situation is hypothetical, what is for certain is that this way, the bank’s lending book gets better month by month, the buyer gets on the property ladder quicker and saves probably 10-15 years of unnecessary rent. All sides win.
So, what is the issue?
MARS: A Referral Agency
When a lender completes a mortgage application and they and the borrower know that the plan is clearly affordable, but the deposit is too low owing to the current system (see Tenant A’s case), then both should be allowed to refer the request to a referral agency: the Mortgage Application Referral System [MARS].
This agency could be comprised of sensible people of various backgrounds who assess cases on affordability grounds. They can then provide certificates to lenders saying that in this case, it is justifiable to lend up to 5.75 times one’s gross income. The lending is on a five-year fixed rate of interest at whatever percentage the lender sets, the mortgage indemnity can be paid by the applicant and then the applicant’s spare income can be paid on top of monthly payments for those first five years to bring the loan down.
One might ask how we’d fund something like MARS? Well, with the advent of Teams and Zoom technology, no physical premises would be necessary. Panels of five-to-10- people could convene and assess all the information and key data, and probably give an acceptance or decline in 30 minutes.
The applicant could pay perhaps £250 for the service, and possibly the lender could pay this also. So, the system would possibly make a large profit and would cost little to run.
The Result
Tenant A could start with a 100 per cent mortgage, have 75 per cent left to pay off within five years, and while not guaranteed could also benefit from increased equity through property price inflation.
The Current System
In my opinion, the system was never and still is not fit for purpose.
It prevents good quality and creditworthy people from acquiring a home on the account of not having a large enough deposit. This negatively affects them, leads to more money being wasted on rent and nobody wins.
My hope is that we can sort out this outdated nonsense, create hopes and possibilities for all parties and ensure a positive outcome for everyone.
What Next?
Surely, there is nothing to lose and everything to gain by trialling it.
Let’s fight the decades-old nonsense and institute a new system which is dynamic, responsive, and probably enables hundreds of thousands more people per year to buy a home that they would have otherwise been denied.
The Bank of Mum and Dad also benefits from this too. Funding a first-time buyer’s deposit in London costs around £125,000, and if loving parents’ finances don’t capsize with that contribution, then they almost certainly will if they are expected to shell out the same sort of amount for two or more other children that they have who want to buy their first property.
The system I’ve suggested significantly reduces this and we can enhance and build upon this idea where required. But we cannot hope to do this without looking at it, trying it and debating it.
I have no political attachments, but I do have one thing in my favour: a desire to positively impact the lives of others.
Year-after-year, decade-after-decade, I see nothing which truly moves the game on, and consequently young people’s hopes and aspirations are dashed. And it can all be avoided.
Now is the time to look at the possibilities and aim for MARS!
