Money: Shoot down the MIGs and help property buyers

HERE'S a riddle. What sort of insurance policy is compulsory, often costs more than pounds 1,000, and is totally worthless? The answer is a mortgage indemnity guarantee (MIG) - sometimes called a mortgage indemnity policy (MIP). Whatever the name, it is the biggest (perfectly legal) financial rip-off many of us will ever encounter, writes Isabel Berwick.

The vast majority of mortgage lenders force home buyers to buy a MIG when they borrow more than 75 per cent or 80 per cent of the value of their home. The banks and building societies say they are taking a risk by lending you more than 75 per cent of the value of the house, so you have to pay them to insure that risk. The lender then buys a MIG policy from an insurer on your behalf. But you have to pay for it - and you don't get any choice at all about which policy it buys or how much you pay. The cost of a policy covering a pounds 50,000 loan making up 95 per cent of the property value might be anything from pounds 774 at Nationwide to pounds 1,052.64 at Abbey National.

Campaigners against MIGs say that home buyers have been paying through the nose for these policies for long enough. Alastair Conway, of Clark Conway, a firm of independent financial advisers in Wimbledon, believes that lenders make around 30 per cent commission on each policy they sell - although borrowers never know this because lenders are not obliged to disclose it. Mr Conway believes the way forward is to crack the lenders' monopoly over these policies. "We want lenders to state what they require from a MIG policy. Then consumers would be able to go to the whole market to sort out a MIG, in the same way they would sort out home or car insurance. It's the only way to drive costs down."

Because first-time buyers often have to borrow most of the cost of their new homes, they tend to be particularly stung by MIGs. Conveniently, almost all lenders allow them to add the cost to their loans - an extra pounds 1,000 can be difficult to find up front.

Lenders often hide the MIG behind names such as "high lending fee" or "additional security fee". But a MIG by any name which ends up being repaid over the whole 25 years of the loan also generates massive interest payments for the lender. For example, a pounds 910.50 MIG payment covering 95 per cent of a pounds 50,000 home value at Northern Rock, added to your mortgage, mushrooms into a total cost of pounds 2,292 over 25 years.

Having paid out such a huge amount of money, you might assume that a MIG gives you lots of protection in case you fall on hard times and can't make mortgage repayments. Not so. The MIG is there to protect the lender. If you default on the mortgage, the lender can claim on the policy - because you turned out to be a liability. And then they can even come after you for the arrears as well. So how do you get round the problem?

There are ways to avoid paying a huge MIG. The obvious one is to save up 25 per cent of the house's value as a deposit. If this isn't feasible, you should be aware that lenders charge for the MIG in "bands" and try to keep out of the most expensive band. Most lenders charge at three rates: borrowing up to 80 per cent of property

value, up to 90 per cent and up to 95 per cent. MIG premiums are calculated in each band as a percentage of the amount being borrowed above 70 per cent or 75 per cent of value.

For example, Bradford & Bingley, which is fairly typical, would charge you 5 per cent of the amount borrowed in the bottom band (up to 80 per cent), 7 per cent in the middle and 8.6 per cent in the top (90 to 95 per cent) band.

Siobhan Hotten, of John Charcol, a firm of independent mortgage brokers, says: "If borrowers are negotiating the price of a property and are tempted to up their offer, they may bump up the MIG cost by jumping into the next band as well as increasing the interest on the mortgage with a higher borrowing."

A handful of lenders offer fairer deals. Nationwide charges lower MIG rates than others and asks home owners who cannot pay up front to spread the cost over just the first three years of the loan. Cheltenham & Gloucester does not charge MIGs but has slightly higher rates of interest.

Direct Line Mortgages has scrapped MIGs altogether. Gordon Blair, its financial director, is critical of traditional lenders making what he says is easy commission at borrowers' expense. Direct Line instead focuses on how it selects its borrowers, using a different set of rules for applicants to traditional lenders. "We look at overall income and expenditure and assess ability to repay, rather than using income multiples," says Mr Blair.

He believes other lenders will eventually be forced to follow Direct Line's example and scrap MIGs. "We know the Bank of England is very much in favour of the approach we are taking," he says. There could be good news yet for beleaguered borrowers struggling to buy homes in an overheated market.

q Nationwide: 0800 302010. C&G: 0800 272131. Direct Line: 0181-649 9099.

HOW DO MIGS WORK?

q A mortgage indemnity guarantee (MIG) is an insurance policy taken out by your lender when it lends more than 70 per cent or 75 per cent of the value of your property. The theory is that it is taking on more risk by lending you a high percentage of the total value.

q Watch out: banks and building societies often disguise a MIG payment by calling it a 'high lending fee' or 'an additional security fee.'

q You have to pay for the MIG, but it only protects the lender against the risk of default. The lender can only claim after a house has been repossessed and sold for less than the outstanding mortgage. The insurer pays the difference, so the lender loses nothing.

q Under what is called 'subrogation' the insurer can then reclaim from you what it has paid to the lender to make up the shortfall. Usually the money will be claimed by the lender and repaid to the insurer. If you do not pay up voluntarily you may face legal action.

q Contrary to popular belief, you cannot just move out and hand back the keys when you get into mortgage arrears.You can be pursued for what you owe to lenders for 12 years (five in Scotland).

*The Council of Mortgage Lenders produces a borrower's guide to mortgage indemnity policies: 0171-440 2255.