A mortgage worth more than the value of the property may sound like the perfect solution to cash-strapped buyers, but in the week that the Financial Services Authority warned lenders that they could be lending too much, experts are advising that negative equity could be one compromise too far.

Offering mortgages worth up to 130 per cent of a property’s value is just one of the increasingly inventive methods that lenders are pushing to maintain demand in the housing market in the face of astronomical prices, but fears are growing that lending higher amounts could discourage borrowers from saving for deposits, which reduce the interest rate on the loan. The average first-time buyer’s deposit is 10 per cent, rising to nearly 30 per cent for home movers, according to the Council of Mortgage Lenders.

HBOS launched 125 per cent loan-to-value (LTV) deals through Birmingham Midshires, its specialist lending arm, this week. It joins a small group of lenders in the 100 per cent-plus loan market, including Northern Rock, Coventry Building Society and Mortgage Express. Two, three or five-year fixes at 5.89 per cent, or a two-year tracker with a rate pegged at 1.14 per cent over base rate, are available on secured loans up to 95 per cent LTV and up to 30 per cent, or £30,000, whichever is lower, as an unsecured loan on top.

James Cotton, of London & Country, the mortgage broker, says: “The rates on offer are on a par with those already available from Northern Rock and Coventry Building Society, but a large new lender entering the market will increase competition and demand.”

HBOS will target graduates and professionals with high future earning potential. Divorcees who have no savings could also benefit. However, the bank says that it will apply stringent credit checks to applicants and expects to decline more than half of all applications because of the risk involved with this kind of deal.

While the extra cash can be useful for low earners who do not have a deposit and need help to cover moving expenses, such as stamp duty, legal fees, surveyor’s fees and hiring a removal firm, the loans work out more expensive over the long term. They are also high-risk.

Interest rates, though lower than most standard personal loan rates, are higher than typical mortgage rates. The average interest on a £25,000 loan, the maximum unsecured personal loan amount, repaid over five years would be 7 per cent — more than one percentage point higher than the HBOS loan. Rob Clifford, chief executive of Mortgageforce, the broker, says: “Homeowners borrow from other sources at higher rates. Why would you borrow at personal loan rates when you can get similar funds at attractive mortgage rates?”

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Although lower interest with a high LTV may be attractive, these deals are more expensive in the long run because interest will be paid over a longer period. Melanie Bien, of Savills Private Finance, says: “While higher LTVs result in a lower rate of interest, you could end up paying back the debt over a longer period — the mortgage term — and pay more interest.”

Last week’s rise in interest rates, to 5 per cent, and speculation that house price growth could cool over the coming months have prompted fears that borrowers taking out the loans could still be in negative equity when they want to resell and may struggle to repay the loans. They could be forced to stay in their homes for many years, until the equity has grown enough to pay off the debt.

Ms Bien says: “Borrowers should be wary. Interest rates can be much higher than if you have a deposit because you are viewed as being a greater risk. You are also in negative equity because your property is worth less than the mortgage. If property prices fall further, you will slip even deeper into negative equity and will not be able to sell until the property is worth more than the mortgage, or you will have to find the shortfall in the selling price and the mortgage to clear your debt with the lender.”

Borrowers who use high LTVs to pay off other debts on credit cards and store cards should also be careful. Ms Bien says: “Those who add debt to their mortgage need to be disciplined and cut up the plastic so that they are not tempted to overspend again. They must then make sure that they overpay on the mortgage when possible to reduce the debt.”

CASE STUDY: Including the kitchen sink

Lisa Thompson, a civil servant, and her husband, Adam, an engineer in the RAF, took out a 125 per cent loan from Coventry Building Society in May to buy their first home in Tranmere on the Wirral.

Lisa, pictured with their daughter, Holly, says that she and her husband chose the deal because they needed to clear a personal loan and wanted to replace the kitchen and decorate their new home. The Thompsons bought the three-bedroom terraced house for £96,950 but borrowed £113,000, with 95 per cent secured against the property and the remaining 30 per cent an unsecured loan. Their monthly repayments are £600.

Lisa says: “We wouldn’t have been able to buy any other way because we had no savings. We are managing fine with the repayments.”

For more on the housing market visit www.timesonline.co.uk/mortgage

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