House deposit explained

The deposit is the part of the purchase price you pay from your own money, with the rest coming from a mortgage. Its size decides whether a lender will take you on and how much the borrowing costs over the life of the loan. A slightly larger deposit often saves more than the extra money itself.

What a deposit is and what it is not

A deposit is the gap between the price and the mortgage. The loan to value ratio is that mortgage expressed as a percentage of the property value, so a mortgage covering most of the price is a high loan to value mortgage, and those carry higher rates because the lender has more to lose if prices fall.

The deposit is not a fee, so it is not lost. It becomes your equity from day one. What it also does is decide which products you are offered, because lenders price in bands, and crossing from one band to the next can reduce the rate on the whole loan rather than only the portion above the threshold. The deposit is a separate amount from the money paid at exchange, which comes later and means something different.

• Loan to value - The mortgage as a percentage of the property value. Lower is cheaper.
• Equity - Your deposit plus any rise in value, minus the mortgage.

How the size of the deposit changes the loan

A bigger deposit does two things at once. It reduces the amount borrowed and moves you into a lower risk band with a lower rate. Over a long term, a rate difference of a fraction of a percent compounds into a large sum, which is why improving the deposit by a few percent is often worth waiting a few months for. It also makes the monthly payment more comfortable under the stress test a lender applies.

The higher the loan to value, the more closely lenders look at everything else: income stability, existing credit commitments and other loans. Borrowing to top up a deposit usually backfires, because the repayment counts against affordability and many lenders treat borrowed money as not being a genuine deposit at all. Gifts are usually acceptable, but the donor has to confirm in writing that it is a gift, and anti-money-laundering checks apply to it.

• Rate bands - Crossing a threshold reduces the rate across the whole loan.
• Gifted deposits - Allowed by most lenders with a signed declaration from the donor.

Deposit is not the whole bill

The money set aside for the deposit is rarely the total cost of buying. In many countries a purchase tax applies, charged as a percentage of the price and payable soon after completion. Add the solicitor or conveyancer, the survey, the mortgage arrangement fee, a valuation fee, searches and the cost of moving. None of it is optional, and all of it comes out of savings many buyers have already spent on the deposit.

Two more things are worth planning for. The property will need work; even a well kept house usually needs something in the first year, from a boiler service to a new washing machine. And mortgage payments can rise if the rate is not fixed. Keeping a modest emergency fund after completion rather than spending everything means the first unexpected repair is an annoyance rather than a crisis.

• Purchase tax - Charged on the price in many countries. First time buyer relief varies.
• Moving costs - Removals, storage and the first round of repairs.

The deposit paid at exchange

When contracts are exchanged, the buyer normally pays a deposit to the seller's solicitor, traditionally ten percent of the price though five percent is sometimes agreed. That money usually comes from the same savings as the mortgage deposit, but it is a separate thing: it happens at exchange, and contract law protects it. Once contracts are exchanged the deal is binding, and a buyer who pulls out without a legal reason loses the money.

That is why nobody should exchange before the mortgage offer is in place, the searches are back, and the solicitor has confirmed the funds for completion. It is also why a large non-refundable payment should never be made to a seller directly. If the deposit sits in a fixed term account, check the maturity date well before exchange, because money that cannot be released in time can cost you the purchase.

• Exchange - Contracts become binding. Pulling out without cause forfeits the deposit.
• Held by - The seller's solicitor until completion. Never pay a seller directly.

Building the money and where to keep it

Work backwards from a target. Decide the price range, subtract the mortgage you can realistically get based on income and current rates, and the gap is the deposit, plus the other costs above. Divide that by the months until you want to buy and you have a monthly saving target that is either achievable or a signal that the timeline needs to stretch. Holding the purchase for a year is often cheaper than borrowing at a high loan to value.

Some countries run state backed savings schemes for first time buyers that add a bonus to money saved towards a first home. Rules differ, including price limits and the saver's age, so check current terms for your country. Keep the money accessible and low risk. Funds needed within a year or two do not belong in investments that can fall shortly before you complete.

• Work backwards - Target price minus realistic mortgage equals your deposit.
• Accessibility - Fixed accounts and investments can delay a purchase at the worst moment.