First-time buyers in the UK have recently been finding it harder and harder to secure a place on the property ladder. With rising house prices and increasing competition across the market, it’s hard for first time buyers to compete for real estate. The UK Government has recognised this difficulty, and has introduced a series of measures to help make property more accessible for those with limited spending power. Amongst these measures is the Help to Buy mortgage scheme, which incentivises mortgage providers to offer finance to first-time buyers who can’t afford a large deposit. In this article we’ll look at how the Help to Buy mortgage scheme works, who it’s designed to help, and when it can be applied for.
What are the Help to Buy Schemes?
Over the past fifty years, homes have become much more expensive relative to the average salary, which has made it increasingly difficult for buyers to purchase their own home. The UK Government’s Help to Buy schemes are designed to stimulate the national real estate market by making it easier for buyers to afford to own houses. These are a set of schemes which work to provide funding for first time buyers through a diverse set of mechanisms – the Help to Buy ISA, for example, is a savings account which provides a 25% bonus payment if it’s used to pay towards the purchase of a qualifying home. Buyers can also choose to participate in the Shared Ownership scheme, which allows them to purchase a percentage of a home’s value in partnership with a housing society.
The Government has also worked to level the playing field for first time buyers, who have seen fierce competition for property from buy to let landlords and existing homeowners. These buyers usually have access to more capital and earning power, and so can afford to outbid first time buyers. In response to this, the Government has introduced a 3% surcharge on Stamp Duty for any buyer who is purchasing a second home. This may not sound like a lot, but as it’s calculated from the total value of the property it can easily amount to a five-figure sum!
By making it cheaper for first time buyers to secure funding, the Government hopes to increase home ownership and improve the stability of the UK real estate market. The Help to Buy Mortgage Guarantee scheme is only one facet of the package of deals which have been created, but is one which can significantly benefit first time buyers.
Mortgage and Deposit Basics
A standard residential mortgage is a large loan, and the initial deposit which the borrower makes determines how much the lender is required to put in. The borrower’s deposit is also an indicator of the loan’s security, as a homeowner with a great deal of money already sunk into their property stands to lose more if they default on their mortgage payments. This is part of the reason why banks typically offer discounted interest rates for larger deposits, as they’re seen to be a safer investment. Smaller deposits tend to attract the highest interest rates, which can make it difficult for first time buyers to take out an affordable mortgage – not only is it hard for them to afford a deposit, but they’re also forced into taking out the most expensive option available.
The size of a mortgage relative to the value of the property is expressed as the “Loan to Value” ratio, or LTV. A £20,000 deposit on a £200,000 property would equate to 10%, with the remainder of the purchase price funded through the mortgage – since the mortgage makes up 90% of the property value, it would have an LTV of 90%. Mortgages with a high LTV are expensive, reflecting the higher risk to the lender, and the Help to Buy mortgage scheme is a way of reducing the lender’s risk in return for a lower interest rate.
How does the Help to Buy Mortgage Scheme Work?
It’s easy to trace the concept behind the Help to Buy mortgage scheme: first time buyers are finding it hard to put a large deposit together, and the high interest rates on high LTV mortgages are making them difficult to afford. Since the price of a high LTV mortgage reflects the additional risk of a default, reducing this risk would consequently allow mortgage providers to offer high LTV mortgages at a cheaper rate. Of course, it’s hard for the Government to guard against the risk of borrowers defaulting, short of actually providing funding. Instead, the UK Government guarantees 30% of the mortgage against default, allowing lenders to recoup a substantial portion of their investment even if the borrower is unable to meet repayments.
The scheme therefore doesn’t fund buyers directly. It’s there to reduce the risk to lenders of approving high LTV mortgages by ameliorating the potential loss if the borrower fails to make payments. The Government isn’t actually financing anything upfront – all it’s doing is offering mortgage providers the option to make high LTV mortgages more viable. It’s important to understand that the Government isn’t paying any portion of the mortgage, and the entire loan will have to be repaid in full by the borrower.
Since the scheme essentially alters the risk/reward equation for mortgage providers, it incentivises them to offer these products at more reasonable interest rates in order to compete. Thanks to the reduced potential risk of these loans, banks have begun offering high LTV mortgages to buyers at lower interest rates, which provides more options for funding to first time buyers. However, because the scheme was designed to stimulate a specific sector of the economy (namely first time homeowners) there are several criteria which must be filled in order for an applicant to qualify.
Who can apply for a Help to Buy Mortgage?
A cheap mortgage with a small deposit sounds like a homeowner’s dream, but if this was made available to all buyers it wouldn’t serve to level the playing field for homeowners rather than landlords. Therefore, there are several requirements for the scheme which potential borrowers have to satisfy:
- The property must be worth £600,000 or less. This is a fairly high cap, given that the average house price across the UK as of November 2016 is £218,000. This allows for buyers who have large families or who live in expensive areas to take advantage of the scheme as well, but it’s worth noting that this value is reduced to £300,000 in Wales. This high threshold also lets second-time movers take advantage of the scheme to move into a larger property, improving the mobility of people who are looking to climb the property ladder.
- The property must be within the UK. The scheme is designed to help stimulate the UK domestic real estate market, and the property must be located within the UK and Northern Ireland.
- The property does not have to be a new build. It’s worth mentioning that a property does not have to be newly-built to be appropriate for the Help to Buy mortgage guarantee scheme, because many of the Government’s other Help to Buy schemes have this requirement. This is because the Government is looking to incentivise the rapid construction of new properties to help reduce the shortage of housing in the market, but in this case, allowing mortgages to be taken out on second-hand property increases the appeal for buyers.
- The mortgage must be a repayment one, not an interest only payment plan. Interest-only mortgages are often used by landlords to reduce the monthly cost of mortgage payments; as they aren’t responsible for repaying the mortgage until the term expires, their monthly payments only consist of contributions towards the interest costs. These are typically not offered to residential borrowers because they’re a lot riskier for the lender, and the Government understandably does not want to incentivise lenders to finance overly risky loans. Therefore, the borrower must be making contributions towards the repayment of the mortgage throughout the term as part of the Help to Buy mortgage conditions.
- The property cannot be let out to anybody else: Since the scheme is designed to put property into the hands of homeowners, not landlords, this clause is designed to eliminate the possibility of buyers renting out their home whilst continuing to live in rented accommodation themselves. This would reduce the amount of housing stock available to buyers who want to buy a home of their own, and do little to reduce the shortage of available housing stock on the market.
- The mortgage cannot be taken out by a company. Similar to the above condition, the mortgage cannot be paid to a company. Although the company may not want to actually let the property out, it’s unlikely that the property would be put to permanent residential use if it was owned by a business.
- The Help to Buy mortgage must not be used in conjunction with any other Help to Buy schemes. The potential for buyers to exploit the system by combining multiple offers together is guarded against by this clause; you must choose the scheme which best suits you, and not a combination of them. The only exception to this is the Help to Buy ISA, which can be used with any of the other schemes.
- The deposit must not come from a publically-funded source. The deposit must be provided by the borrower themselves. Because the Government is guaranteeing 30% of the loan value against default, there must be some incentive for the borrower not to default. Otherwise, the Government is losing twice; it’s funding a mortgage with its own money, then paying it off when the buyer defaults.
- The size of the mortgage cannot be more than 4.5 times the buyer’s annual household income. Very few mortgage providers would approve a large mortgage with a small deposit for a buyer who was obviously unlikely to be able to repay it. However, the insurance package which the Government is offering could persuade some lenders to approve inappropriate loans, which is why this condition exists. By tying the mortgage to the borrower’s income, the Government ensures that buyers won’t take advantage of the scheme to take out unreasonable mortgages on properties they can’t really afford.
How can I find Help to Buy Mortgages?
The UK Government has created a list of mortgage providers and banks who are offering mortgages under the Help to Buy guarantee scheme. Because the service must be opted into, any bank which decides that Help to Buy mortgages offer a good deal will be able to begin offering them to its customers. You must determine whether or not you are eligible for the mortgage before applying, and will need to supply evidence of your situation to be approved.
Help to Buy Mortgage Lenders
Lenders that participate in the Help to Buy Mortgage Scheme:
- Al Rayan Bank
- Aldermore Bank of Ireland
- Post Office Mortgages
- Ulster Bank
- Virgin Money
Benefits of a Help to Buy Mortgage
A Help to Buy mortgage offers several key advantages to borrowers which can make it more appealing than other mortgages. Firstly, it’s a fairly flexible scheme which provides funding for many different types of buyer. Many of the Help to Buy schemes are only open to first time buyers, or to those who are purchasing a newly built property, whereas the mortgage guarantee scheme can be used in many different situations. Since homeowners are able to invest in properties up to £600,000, it’s possible for homeowners who want to purchase a larger, more valuable home to make use of the scheme, rather than just first time buyers. This helps increase the fluidity of the real estate market by making it easier for all types of buyer to secure funding for their purchases.
As well as being a flexible form of finance, the Help to Buy guarantee scheme has reduced the cost of the average high LTV mortgage. This has made home ownership a more achievable goal for many long-time renters trying to save up for larger deposits, as it’s now more affordable to take out a mortgage with a high LTV. In addition to this, the Help to Buy mortgage is still a regular mortgage, offered without any direct input from the Government. This means that the owner will have 100% equity once the balance of the loan is repaid, which makes it easier for them to climb on to the next rung of the property ladder by selling their property.
Disadvantages of a Help to Buy Mortgage
Help to Buy mortgages aren’t the answer in every scenario, and don’t provide solutions for every buyer. In many cases, a mortgage with a high LTV is still fairly expensive when compared to those offered on loans with a larger deposit, which means that the appeal of Help to Buy mortgages is largely limited to people struggling to save up for a larger deposit. In addition to this, although the conditions of the mortgage scheme are fairly wide, they still limit the value of the property which can be purchased. This may mean that in some situations buyers find that Help to Buy mortgages simply don’t offer the right answer to their problems.
What are the alternatives to a Help to Buy mortgage?
Help to Buy mortgages are only part of the Government’s wider Help to Buy scheme, which includes several alternatives to high-LTV mortgages. The two main alternatives are the Equity Loan Scheme and the Shared Ownership Scheme, both of which have different criteria and options to the mortgage guarantee scheme.
The Equity Loan Scheme functions in a similar way to the mortgage guarantee in that buyers only need to provide a 5% deposit. Behind the scenes, though, the contract is significantly different: the Government provides up to 20% of the property value as an equity loan, meaning that they essentially purchase a stake in your property. The benefit of this is that buyers may be able to secure a lower interest rate, because the mortgage they apply for will have a much lower LTV. On the downside, though, they’ll have to repay the equity once they sell the house. This scheme is also only available for purchasing new build properties, too, which limits the circumstances in which it can be used.
The Shared Ownership Scheme functions differently to the other two schemes, but with the same basic principle. This essentially offers buyers to purchase a “share” in a house, buying it jointly with a housing association. The buyer then pays rent on the portion of the house which they don’t own, in addition to paying off the mortgage on the part they do own. This allows buyers to reduce the upfront cost of the purchase and apply for a smaller mortgage. The smaller the mortgage, the larger the deposit becomes relative to the loan, and (usually) the lower the interest rates are. The buyer can then choose to increase their shares of the property over the years, eventually buying out the housing association.
Help to Buy Mortgage Guarantee Scheme – final takeaways
As a scheme to help stimulate the housing market, the mortgage guarantee scheme is a good way to remove barriers to entry for buyers who are struggling to break in to the market. Whether they’re first time buyers or second movers, the ability to take out an affordable mortgage with only a relatively small deposit promotes market mobility, and also galvanises the UK real estate sector.
Other resources about Help to Buy Mortgages
Official resources about UK financial regulation:
- Bank of England Website
- Prudential Regulation Authority
- Financial Conduct Authority
- The Financial Policy Committee
- Financial Services Compensation Scheme
Other Unofficial Guides
Covering areas of UK financial regulation
- Buy To Let Mortgage
- Foreign Currency Mortgage
- Hotel Mortgage
- Listed Buildings Insurance
- Million Plus Mortgage
- Short Lease Mortgage
- The Bank of England
Research provided by Falbros