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The 95% interest-only mortgage for first-time buyers

To some it may sound like a helping hand onto the property ladder, but to others it will seem like a mortgage deal that harks back to the lending madness of the 2000s. 

First-time buyers looking to limit their outgoings can benefit from a unique deal, which lets them buy a home with an interest-only mortgage for three years if they put down just a 5 per cent deposit. 

Newbury Building Society’s Home Starter mortgage is a 95 per cent loan-to-value deal, which starts as interest-only but then switches to a capital repayment mortgage after a fixed three-year period.

Borrowers with just a 5 per cent deposit can keep their monthly outgoings to an absolute minimum for the first three years they are in their home, but the problem is that monthly payments will then rocket.

Both fixed and variable interest-only deals revert to a capital repayment plan after three years 

The mortgage rate is fixed at 3.8 per cent for the first three years while the loan is set up as interest-only, after that it shifts to a capital repayment mortgage and the building society’s standard variable rate, which is currently 4.45 per cent.

For someone with a £150,000 mortgage on a 30-year term would see monthly payments shoot up from £475 to £796.

The big rise in payments invites comparisons with heavily-criticised ‘teaser rate’ mortgages, which were a feature of the US market before the financial crisis, and the plethora of banks and building societies in the UK willing to lend interest-only to those with small deposits in the property boom years running up to 2007.

Newbury BS says that it tests affordability based on the capital repayment mortgage at the higher rate.

Nonetheless, this niche mortgage is a controversial product. We take a look below at how it works and what other deals it compares to.  

The 95% interest-only mortgage 

The society’s Home Starter mortgage is fixed at 3.8 per cent for three years interest-only and comes with a £600 arrangement fee. 

Once that initial deal period ends it moves to a capital repayment mortgage and Newbury’s standard variable rate, which is currently 4.45 per cent but could be higher then if interest rates rise.

It comes with free valuations, is portable, has a minimum loan size of £50,000 and a maximum loan size of £300,000. 

It also has early repayment charges of 3 per cent for the first two years, then 2 per cent for the remaining fixed term. After that borrowers are free to remortgage.

During the fixed-term period, borrowers are permitted to make overpayments up to 10 per cent of the original loan amount per year. 

There is also the option of a discounted variable rate at 1.01 per cent discounted to the lender’s SVR, currently at 3.44 per cent, again with a £600 fee.

This is quite a bit cheaper than the fixed rate deal but is likely rise if the Bank of England shifts interest rates up at in the next three years, as is widely expected.

Again, once the initial three-year period is over, the borrower will be moved onto a capital repayment mortgage and the lender’s standard variable rate.

Roger Knight, lending manager at Newbury Building Society said: ‘The majority of customers at 95 per cent choose to pay capital repayment from the outset, and the uptake of interest-only has been slow. 

‘However, we are comfortable with this because the product has always been seen as an alternative option for the customer.’ 

What are the risks? 

There are potential downsides to this deal for borrowers who have not done their homework.

The first and most obvious is that the homeowner will not actually be paying down their loan for the first three years of the mortgage. 

After the initial three-year period, they will still be left with just 5 per cent equity in their property. 

This is more expensive in the long-run and doesn’t provide much of a buffer against negative equity if house prices fall.

The second is the leap in monthly outgoings once the three year period ends and the borrower moves to both a capital repayment mortgage and the lender’s standard variable rate of 4.45 per cent.

Monthly payments will shoot up once both the interest-only period and introductory rate end 

Monthly payments will shoot up once both the interest-only period and introductory rate end 

In some cases this could nearly double monthly outgoings. 

For example, on a £200,000 mortgage taken over 25 years, the borrower could expect to pay £648 a month in the first three year once fees have been factored in. 

Howeve,r at the end of the fixed rate period the same borrower would see their monthly payments jump up to £1,189 per month.

Fortunately Newbury calculates borrower affordability on the capital repayment component of the deal, which means borrowers will only be allowed to take the deal if they could in theory keep up with the higher monthly repayments once the fixed period ends.

There are no early repayment charges after the original three year period is over, however, so there would be nothing to stop the borrower from remortgaging once the fixed rate period has come to an end.

However, as no equity has been paid down they would still have to remortgage to a 95 per cent loan-to-value deal, which again would increase monthly repayments if they switched to capital repayment – and this is assuming house prices don’t fall in that time. 

If house prices do fall, the borrower would be unable to switch as their loan-to-value would be above 95 per cent, and they could even fall into negative equity. 

It’s innovation but comes with a health warning   

Andrew Montlake of mortgage broker Cicero

Andrew Montlake of mortgage broker Cicero

Andrew Montlake of mortgage broker Cicero said: ‘It is good to see that innovation is alive and well in the mortgage market and this product is a throwback to the old “low start” mortgages. 

‘Whilst this is likely to appeal to first-time buyers looking to minimise their outgoings in the early years there are some dangers associated with such a product that buyers need to be aware of.

‘Although affordability will be measured on the full capital repayment basis, it is easy for borrowers to forget that their monthly payments will increase dramatically after three years. 

‘It could be very difficult to remortgage to another provider and the borrower could find themselves having to stay with whatever rate their existing provider puts them onto.’