What is a Mortgage Deposit?

A mortgage deposit is the amount of money a home buyer pays in cash for a home, with the rest of the money being provided by the mortgage company as the loan. The relationship between the mortgage deposit and the total purchase price is known as the loan-to-value ratio. The loans market has historically swung back and forth to try to find the right ratio. If it is too high, potential home buyers find it harder to raise the necessary cash; conversely, if it is too low, lenders are at increased risk of losing out if the borrower defaults.

The basics of a mortgage deposit are simple. If a home buyer wants a mortgage for a $100,000 US Dollars (USD) property, and the mortgage lender requires a 15% deposit, then the loan is for $85,000 (USD) and the buyer provides the remaining $15,000 (USD). This set-up can be described in two ways: a 15% loan-to-value ratio, or an 85% mortgage.

Raising the cash for the mortgage deposit can be one of the toughest parts about buying a first home. This is because many borrowers live in rented accommodation prior to buying, meaning the rent eats up a lot of their income and makes it hard to save money. Fortunate first-time home buyers might borrow the cash for the deposit from parents or other relatives.

It may seem that lenders would do better by requiring a lower deposit because this is more attractive to borrowers and because it means the total interest paid on the loan will be higher. There are two main disadvantages to lower deposits, however, which make many lenders prefer to require larger deposits. The first reason is that borrowers who have saved up a larger deposit may seem more financially responsible and thus more likely to repay. Ironically the second reason involves borrowers who don't, or rather can't, repay the loan.

The smaller the deposit, the smaller the initial gap between the value of the home and the money the borrower owes. The smaller this gap, the more risk there is that housing market fluctuations mean the market value of the house drops below the amount still remaining on the mortgage, particularly in the case of an interest only repayment mortgage, a situation known as negative equity. This creates the risk that the homeowner will be unable to move house as the sale price won't raise enough to settle the mortgage. It also creates the risk that if the lender is forced to foreclose, the sale of the home won't raise enough cash to get back the outstanding loan.

Despite these risks, some lenders have required low deposits of as little as 5%. Others have offered 100% mortgages, meaning there is no deposit required, while some even offered loans of more than a 100%, meaning the lender paid the entire purchase price and then lent some extra cash to the borrower. In the wake of the financial crisis that began in 2007 and 2008 and was sparked off by mortgage-based securities linked to loans that had a high default rate, most lenders ceased offering such loans.