First-time buyers imprisoned for three years

One in 20 first-time buyers may be imprisoned in their homes if house prices stagnate. According to Halifax house prices fell in September for the first time in nine months - the annual rate of house-price inflation is now 10.7% down from 11.4% in August.

Homeowners who bought their dwellings a year ago should be, on average, better off today compared to 12 months ago. However, buyers, particularly first-time buyers, who took out 100% mortgages recently, have reason to be concerned. It is estimated that around one in 20 first-time-buyers take out these mortgages to cover the full value of their home.

A dip in house price, albeit a small one, could push recent homebuyers on 100% mortgages into negative equity. This means that they cannot sell, as the amount they owe on their mortgage is greater than the value of their home. It also means that they could be stuck on 100% mortgages for some time.

Currently, 100% mortgages still represent a relatively small part of the mortgage market, and are offered by just a handful of providers. Interest rates on these home loans, which are clustered around 6.5%, compare unfavourably with other types of mortgages that are around 1% lower. 100% mortgages are more expensive because of the greater risk that lenders assume, and criteria are expected to tighten following the recent slowing of the housing market.

Without the benefit of rising house prices that increase the equity homeowners have in their houses, borrowers on 100% mortgages will be severely disadvantaged. So, while many homeowners with substantial equity in their home can scour the market for best buys, borrowers on 100% mortgages cannot.

In a stagnant housing market, first-time buyers on 100% repayment mortgages may find that they only have around 3% equity in their homes when their current 100% deal ends. It could take as long as 34 months to build 5% equity in their homes, and considerably longer if house prices fall. What’s more, many first-time buyers take out 100% mortgages on an interest only basis relying on increases in house prices.

The upshot is that first-time buyers may be prisoners in their own home until house prices rise again. Additionally, the scarcity of 100% mortgage providers, and the tightening of criteria, means that borrowers will be restricted to a handful of providers when their current deal, which tends last around 24 months, ends.

David Kuo, Head of Personal Finance, says: “Borrowers on 100% mortgages need to be aware that stagnant house prices may keep them shackled to their uncompetitive lender and prisoners in their own home until house prices rise again.

“However, they can tip the scale in their favour by ensuring that they choose repayment mortgages rather than the cheaper interest-only options. They should also overpay their mortgage as often as they can afford. This will ensure that they are regularly chipping away at their debt. And with more equity in their homes, their choice of mortgage providers improves too.

“100% mortgages are supposed to provide first-time buyers with a helping hand onto the housing market. But in a market where house prices stagnate or fall, what providers give with one hand may be taken back with the other when the mortgage deal ends.”