What Is The Government Mortgage Indemnity Programme? And Why Do Lenders Need It?

The government have announced a new Mortgage Indemnity programme in order to kick start the UK housing market. It will provide first time buyers the opportunity to pay just 5% deposit on a house rather than upwards of 20% which some lenders require. The programme will see government and developers take on some of the risk, in return for the lenders offering the 95% mortgage. But what is mortgage indemnity and why do lenders need it?

Well, let’s get rid of all the jargon and take it back to basics. Mortgage Indemnity is a form of insurance taken out by the mortgage lender as added security in case the borrower defaults on payments.

Take for example, David, he has just purchased a house for £100,000. He got a 75% mortgage and paid £25,000 deposit.

However, on the first day David moves in to the property he has a terrible accident and can no longer work. He has no sick pay or insurance schemes so he is unable to make his first mortgage payments.

The lenders will tolerate a couple of missed payments, but after a few months they are going to get tough, by six months they start court proceedings against David and look to get the house repossessed.

Throughout this time the lenders will incur court fees and solicitor’s charges, not to mention the time it will take. Eventually the Judge says that David is to be evicted but the bailiff costs will be added to the lenders costs. When it’s finally time for David to be evicted, the lenders find that he’s smashed the house up, ruining the bathroom and kitchen.

The house is not in a good state, so they sell it as a distressed asset to builders for £85,000, even though the property was worth £100,000. However, the lender gets the £75,000 they originally lent out plus £10,000 in costs. David loses his £25,000 deposit, but the lender is happy and hasn’t lost anything.

This may seem alright, but if you run the above scenario again, but with a 95% mortgage and just a £5,000 deposit, then the lender is looking at potentially large losses.

Well what’s a lender to do? They could only lend to people who can afford the 25% deposit. That’s a good move from a risk perspective, but they won’t have many customers and it will effectively force the first time buyers out of the market. Most lenders require a 20% deposit from a first time buyer but as the current housing market stands, this would mean that they’d need to save an average of £33,000 deposit.

The other option for the lenders is to take an out an insurance policy in case the purchaser defaults on the loan. That is what Mortgage Indemnity is.

 

With the number of new houses being built at the lowest rate since World War II, the government want to kick start it again by making it easier for first time buyers to buy a house. They plan to do this by introducing 95% mortgages. But with the economy as it is the lenders are reluctant to commit to 95% mortgages because, as we’ve seen, they are high risk.

The government are combating this, by taking on the risk using the tax payer’s money.

This is how it will work.  The lenders will lend 95 per cent of the property value while the developer will provide up to 3.5 per cent into a centralised ring-fenced fund. This fund will run for seven years. If after that time there has been no default on the loan, the developer can take back its cash.  However, if the property is repossessed and sold at a loss, the lender can reclaim up to 95 per cent of its losses from the ring-fenced fund. If the housebuilder’s fund can’t pay, then the lender can claim from the Government.

This takes out all the risk from the mortgage lenders point of view and it is hoped that it will lead to 100,000 new loans.

Still however, it won’t be easy for the first-time-buyers. One foreseeable problem is the interest rates that the mortgage lenders will charge. At present, only a handful of lenders will lend up to 95 per cent. They include Yorkshire and Clydesdale banks as well as Mansfield, Cambridge, Saffron, Skipton Melton Mowbray and Shepshed building societies. But the rates are high.

Yorkshire Bank has a three-year fixed rate at 6.19 per cent while Skipton’s two-year fix is set at 5.99 per cent. Many of these deals have restrictions and might not lend on new-build property or on flats in high-rise blocks.

The six biggest lenders, including Halifax, Santander and Nationwide Building Society, have all agreed to take part in the mortgage indemnity scheme. This should increase competition and mean interest rates coming down, however, it is thought that even in the best case scenario the rates won’t fall by that much.

Hopefully that will have cleared up what the governments Mortgage Indemnity scheme? Will it work? Well that’s a blog for another.