The bigger the deposit, the better it gets…

April 14, 2020 | William |
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When it comes to borrowing money from financial institutions, it all comes down to risk. The bigger your deposit in percentage terms, the lower the risk you present to the lender. Equally the smaller your deposit, the higher the risk you present to the lender. Therefore, the bigger the deposit, the better it gets…

Let’s not forget a mortgage is a loan secured against the property you’re purchasing, therefore if you do not keep up your repayments, your property could be repossessed – so to illustrate two different risk scenarios, imagine two situations;

1) You purchase a property with a 40% deposit. 12 months later having never made a mortgage payment you’re getting repossessed and house prices have fallen by 15%. In this example, there is still enough equity in the property on sale to ensure the lender get their money back.

2) You purchase a property with a 5% deposit. Same again, 12 months later having never made a mortgage payment you’re getting repossessed and house prices have fallen by 15%. In this example, you’re in negative equity and the lender will not be able to recover all the money lent against the property.

Although these examples go from one extreme to the other, you can see from the above how having a bigger deposit would put the lender’s mind at ease – the larger the deposit, the bigger the safety net or cushion there is to fall back on if it ever came to it.

If we ignore schemes which involve help from family members (and also ignoring the current pandemic temporarily effecting lender criteria) the minimum deposit required to purchase a property is 5% of the purchase price. I’ve known it to take clients of mine as little as 2 years to save a deposit, and as much as 15 years – according to research from Moneyfacts the average time it takes a couple with two incomes, buying outside of London, is almost 4 years to save a deposit.

There are pros and cons to taking longer to save up a bigger deposit, rather than just buying as soon as you’re able to (ie. with a lower percent deposit). For every additional 5% you add to your deposit, you can expect to get a better interest rate. This generally applies all the way up to a 40% deposit, after which the rates tend to stabilise. Not only with a bigger deposit will you get a lower interest rate, but naturally you’ll be borrowing less as well – so with the combination of a reduced loan amount on a reduced interest rate, this equals only one thing – a lower monthly mortgage payment. Additionally, a bigger deposit attracts a more relaxed credit scoring process by the lender, which will benefit those with maybe a lower credit score than they’d like.

However, there is one big pro when it comes to just ‘getting on with it’ and buying as soon as you’re able to. Imagine you hold off for two years to save a larger deposit and in those two years, the property you could have purchased for let’s say £300,000 goes up in value by 3% year on year. After year one it’d be worth £309,000 and at the end of year two it’d be worth £318,270 – an increase in equity of £18,270 which you wouldn’t have if you’d held off. More importantly, it would be someone else’s equity and your purchase price will have gone up when you come to buy in two years’ time… Potentially by more than you’ve managed to save up in those two years.

Ultimately, it all depends on your personal approach and how the property market is reacting in the area you’re looking to purchase. Also, it largely depends on how much you can save each month, and how quickly you could get to that next ‘milestone’. For example, if you currently have a 9.75% deposit (£29,250 on a £300,000 property) then it will almost definitely be worth saving that extra 0.25% (or £750 in this example) to get you up to 10%, as the difference it will make to your interest rate and monthly payments will be noticeable and worth what should in theory be a very small waiting time to get there.
Of course, the above isn’t all extensive, more of a thinking out loud blog – ie. the above paragraph on deposit assumes you’ve got the purchasing fees covered separately, so there’s always more that goes into it… Everyone’s individual circumstances will vary and hence it’s important to get advice from an adviser who will take time to understand your goals and what you want to achieve.
So if you want any advice, or are looking to purchase soon, please feel free to get in touch.