What's the best way to save for a mortgage?

Published by Sam Barrett on 28 March 2019.
Last updated on 10 April 2019

Average homeowner has earned enough by today to pay off 2018 mortgage

One reader is keen to buy a house in the capital but needs to consult on how to save up for a deposit

I’m planning to buy a house in London in the next five years. I’ve saved £10,000 in a Cash Isa and can save £500 a month. Where should I put this money? 

Initial diagnosis

Buying your first home is a major financial commitment, but an exciting one too. Given the amount of money you’ll need to buy a home in London, Patrick Connolly, a chartered financial planner at Chase de Vere, says it is important to have a plan.

He says: “You should have an understanding of the type of property you want to buy, the location and the cost,” he explains. “This will give you a good indication of the size of the deposit you need and whether your savings are on track or you need to adjust them.”

As well as assessing the cost of your future home, it is also worth working out how much you will be able to borrow.

“Lenders apply their own affordability tests, which take into account your income level but also your ongoing commitments to give you a personal borrowing amount,” says David Hollingworth, associate director at L&C Mortgages.

“Use the lenders’ mortgage calculators to get an idea of what your borrowing is likely to be.” 

Treatment plan

You also need to find the most suitable place for the money you are saving towards a house deposit. Although you could invest in the stock market and potentially generate higher returns than those from a savings account, Danny Cox, chartered financial planner at Hargreaves Lansdown, says this strategy is too risky.

“With less than five years before you plan to buy a property, sticking with cash is the right thing to do,” he says.

As you’re under 40, he recommends opening a Lifetime Isa (Lisa), which can be used to save towards your first home. You can pay in up to £4,000 each tax year, which counts towards your annual Isa allowance of £20,000.

The key sweetener is that, as well as earning tax-free interest on your savings, the government adds a 25% bonus. This means that if you save £4,000, the government will add a bonus of £1,000, and that is besides any interest you will earn.

Mr Connolly adds: “If you’re buying with a partner, they can also have a Lisa, so you both benefit from the government bonus.”

There are some conditions you need to consider. You can only take money out of your Lisa to buy your first home, once you reach age 60 or if you’re terminally ill. Access it for any other reason and you’ll pay a 25% government withdrawal charge. In addition, it can only be used on properties costing £450,000 or less.    

Given you plan to save £500 a month, Patrick Murphy, chartered financial planner at Zen Wealth, has the following advice: “Start a new Lisa at a monthly contribution of £333.33, with the remaining £166.66 a month going into your existing Cash Isa. With the £10,000 you have already saved, this will give you a guaranteed return of £45,000 for your deposit over the five years, plus the interest you earn.”

Alternative therapies

Although the tax-free interest on a Cash Isa can appear attractive, Mr Connolly says you might get a better return on a taxable account.

“The personal savings allowance means basic-rate taxpayers can earn £1,000 of tax-free interest each year, with this falling to £500 for higher-rate taxpayers,” he explains.

“If a taxable account pays a higher rate of interest, this might be worth considering for the Cash Isa element of your savings.”  

Future side-effects

Although your primary focus in on building up your deposit, also think about the mortgage you can borrow as this can influence when you buy and how much you need to save.

Mr Hollingworth says the market has improved for borrowers with small deposits.

“There is a good range of lenders offering products to those with as little as a 5% deposit but, although rates have been improving, they will still be higher than for those who can stretch to a 10% deposit,” he explains.

The type of home you consider might also entitle you to a helping hand on to the property ladder.

Mr Hollingworth says you may be eligible for the Help to Buy equity loan scheme, which requires a 5% deposit but the government will lend up to 20% or 40% in London.

“This needs to be repaid and will attract a charge after the first five years,” he adds. “Shared ownership could be an option if prices are out of reach. This allows you to buy a share of a property from a housing association and pay rent on the remainder. You can buy extra shares as circumstances change.”

 

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