Help to Buy: A Ticking Time Bomb?

24 October 2018 | William Carrington

Help to Buy (HTB) started in April 2013, with the objective of supporting ‘creditworthy but liquidity constrained’ households who could afford mortgage repayments yet were struggling to raise a deposit. 

At the heart of the equity loan scheme lies an interest-free government loan of up to 20% (40% in London) on the value of a newly built house purchase. Interest-free that is for the first five years – which for those early takers, meant up until April 2018 (more of this later).

The scheme is available on new build properties only and its aim was to help meet buyer demand while increasing housing supply.

When it first began the government budget for Equity Loans (EL) was set at £3.7bn, but in October 2017 it was increased to £10bn to run up until the end of the scheme which was planned for 2021.

According to official statistics by last September (2017) nearly 145,000 properties were bought using Help to Buy loans. About 38 per cent of Help to Buy borrowers have an income below £40,000. Bank of England analysis shows that the average age of a HTB borrower is 31 years.

A REMINDER OF HOW THE HTB SCHEME WORKS...

  • The EL scheme provides a loan of up to 20% (40% in London) of the value of a house costing up to £600k. 
  • The buyer provides a 5% deposit and the bank provides a mortgage on the remaining 55%. 
  • While eligibility is not subject to income restrictions, the income multiple of 4.5 x income is based only on the mortgage element.
  • For the first five years the cost of the government loan is interest-free, but when the five year period comes to an end borrowers will be charged 1.75% on the outstanding amount as interest. This so-called fee will increase each year in line by the retail prices index (RPI) plus 1%.
  • The numbers show that the average interest for those taking an EL is 4% higher than for standard borrowers and that the delinquency (late or missing payments) rate is 0.29%, a little higher than the 0.15% standard borrower.
  • They also show that the total value of the EL is £4.17bn and the total value of sales is £20.82bn, which equates to 286,593 sales between April 2013 and June 2016.

HOW THE NUMBERS STACK UP

A hypothetical example shows how help to buy pans out for a London buyer:

In the first five years….

  • Purchase price                   £300,000
  • 5% deposit                         £15,000
  • HTB                                    £120,000
  • Mortgage                            £165,000
  • Monthly repayments on £165k at 2.02% fixed for 5 years = £446.08 pcm

...And after five years* 

  • HTB interest = £275.00
  • Monthly repayment = £721.08 an increase of £275 (assuming re-mortgage at same rate)
  • Monthly repayment = £1,047.92 an increase of £601.84 (assuming 3.5% SVR)
  • From April this year, 2,000 house buyers who took out the first loan in 2013 will see their monthly housing repayments increase by 62% (higher if interest rates rise or owners remain on SVR).  

*calculations assume no interest rate rise

CONCLUSION

According to the Home Builders Federation (HBF), since the scheme launched, housing supply has increased by 74%, the fastest increase on record (since the 1950s). 

However, there are a few things to keep an eye on…

1. Income multiples

This is based on the debt portion and is set at a maximum 4.5x.  When the interest free period comes to an end the borrower will be subject to two lots of interest – their original mortgage plus interest on the government loan.  The net result is in essence, an increase in income multiples. 

2. Rising interest rates

The rate on the HTB side is initially 1.75% rising by 1% plus RPI of the previous years’ rate

3. Delinquency Rates (or late/missed payments on loans)

Inevitably there will be some help to buy homeowners who struggle to keep pace with the increased interest rates that kick in five years after they first took out the loan.  This could put finances under pressure and make it difficult for them to move

4.Should the market fall

If the market falls there is very little cushion (the original 5% plus any capital repaid) to absorb the fall. 

About the author

William Carrington

Chairman, LonRes

William Carrington, Chairman, LonRes