The government’s Help to Buy loan was launched in 2013 with the aim of helping young people onto the housing ladder.
Available only for new-build homes, the idea is simple: the government lends buyers up to 20 per cent of the cost of the home, and the buyer then only needs a 5 per cent cash deposit and a 75 per cent mortgage to make up the rest.
The government part of the loan – the 20 per cent – is interest-free for the first five years.
Between the scheme’s launch in April 2013 and the end of December 2017, almost 159,000 properties were purchased using a Help to Buy loan.
This year marks the fifth anniversary of the scheme, which means payments on the first Help to Buy loans are now becoming due, initially at a rate of 1.75 per cent. On a loan of £40,000 this equates to £700 a year or £58.33 a month. After that, they will increase by the rise in retail price index, plus another 1 per cent every year, which means that £58.33 monthly repayment will shoot up to at least £91.60 in year seven.
So with this in mind, is the Help to Buy scheme a good investment or is it a ‘buy now, pay later’ scheme about to cause financial problems for many suddenly faced with new interest payments?
You can get on the housing ladder sooner
The first clear benefit of the scheme is that it can help first-time buyers get onto the housing ladder a lot sooner than they may otherwise have been able to. With Help to Buy, borrowers only need to find a 5 per cent deposit, which means not only can they can save their deposit more quickly, but, as house prices have risen significantly over the past five years, means they potentially bought the property for less than if they had had to wait. The value of this has already been demonstrated by the 159,000 who have already used it.
You could buy with a smaller deposit but get better mortgage rates
To buy your first home most lenders are looking for 10 per cent deposit. Which means on a house worth £179,594 (the average cost of a first time buyer property) the buyer would need a deposit of £17,960 and be left with a mortgage of £161,635.
With the Help to Buy scheme, the government puts in 20 per cent and the borrower only has to find a deposit of 5 per cent. This means on the same property, the borrower pays a deposit of £8,980 but is left with a much lower mortgage – £134,696 and therefore a better loan-to-value and consequently a lower mortgage rate. So, not only is the main mortgage lower, but the client also gets a more competitive rate of interest.
You can borrow interest-free for five years
Buying a home is obviously an expensive business, but it does not stop once the contract is signed and the house is bought. There are all sorts of other expenses in the first few years of owning a new home, and the fact the government portion of the loan is interest-free for five years can be very helpful.
However, while the Help to Buy scheme gives those who could not otherwise afford to buy the opportunity to do so, there are drawbacks, and advisers must ensure their clients have carefully considered these before committing to a loan.
The loan gets more expensive
The interest on the government portion of the loan is quite low when it becomes due: 1.75 per cent. However, after the sixth year, the rate starts to increase. The borrower needs to have budgeted for this, which is what the first swath of Help to Buy borrowers are facing right now.
This sudden introduction of charges can cause problems for those who are unprepared
While the interest-free loan seems very attractive at the time, once the borrower has to start paying it back, interest will increase by 1 per cent plus any increase in the RPI each year. So even if the RPI falls at any time, charges on the government loan will still increase by at least 1 per cent, which on a £40k loan is at least £30 a month more each year. This ever-increasing cost is something potential buyers need to be aware of and prepared for.
It is therefore vitally important that advisers make it clear to their clients looking to use Help to Buy that the loan is not interest-free indefinitely, and make sure they are in position to put money aside to prepare themselves financially for when the loan does need to be paid back.
Not all lenders will lend on Help to Buy, which means that when a client does come to the end of their deal, their options may well be restricted. This, combined with the rising costs of the government part of the loan, means clients need to be cautious.
Advisers need to ensure their clients are familiar with the lenders who will remortgage a Help to Buy deal, so they can help their clients to remortgage if need be.
You could fall into negative equity
We know that house prices fall as well as rise, but due to the structure of the Help to Buy loan, there is a risk of negative equity.
There is speculation that Help to Buy has inflated house prices, and that those on the scheme have paid more for their new builds than they are actually worth.
This means if house prices fall, there could be Help to Buy borrowers in negative equity. As first-time buyers quite often move after two or three years, this could cause real problems, especially if these borrowers come to the end of theirdeals and find their LTV has actually increased.
There is also the issue that homes bought new using the scheme are competing with new builds, making it harder for their owners to sell, possibly forcing them to drop their asking prices.
Your home is not 100 per cent yours but you are responsible for it
With a standard mortgage, the lender’s charge only covers the amount owed, with the borrower retaining any additional equity at the point of sale.
With Help to Buy, advisers need to make it clear to clients that the government has a charge for the initial 20 per cent borrowed but will also benefit from any rise in the property’s value, even if this is due to improvements the client has made and paid for.
Advisers also need to make clients aware they will need permission to make any substantial improvements to the property and will pay 100 per cent of the cost of those improvements, but only receive 80 per cent of the profits.
You cannot rent the property out
One of the stipulations of a Help to Buy loan is that you cannot sublet it, something, Dave Miller warns, many people are unaware of.
“If a couple who both own their own homes decide to move into together, it would be quite sensible to move into one property and keep the other one as an investment and rent it out.
“But, if that property was bought through Help to Buy, subletting it puts the owner in breach of their loan agreements. The only way a Help to Buy can be rented out is by repaying the Help-to-Buy part of the loan.”
So is it worth it?
The expectation was that the borrowers’ wages would go up, or the value of their home would increase, or both, leaving them in a position after five years to either pay off the government part of the loan in full or start paying back the loan on top of the rest of their mortgage payments. But for many it may not have worked out like that.
Many houses bought on Help to Buy schemes have not increased in value as much as the owners may have hoped, while some have actually dropped in value, often because the original prices were inflated.
We have also seen wages stagnate, inflation rise and interest rates may rise soon, which means not only will those on Help to Buy see their government loan due for repayment, but could see their monthly mortgage repayments rise too, a double whammy.
The Help to Buy scheme has seen lots of first-time buyers taking on a huge financial commitment, thinking their financial position would improve by the time the first payments were due, but five years down the line some are now finding they are not quite where they wanted to be and this could start to cause affordability issues.
Nevertheless, the scheme has been very useful, and many first-time buyers who otherwise would have not been able to get a foot on the property ladder have done so.
Advisers need to ensure any client looking to buy using the Help to Buy scheme is fully aware of all the pros and cons and that their situation suits the scheme. Once a client is on the scheme, advisers should be contacting them at least annually to ensure they are making preparations forthe future.
We do not want to end up in an interest-only mortgage situation, with customers burying their heads in the sand until it is too late.
Source: FT Adviser