Help to Buy Scheme: The Danger for First Time Buyers

Is the government's new Help to Buy scheme for first time buyers all good news for those wishing to get a foot on the property ladder, or are there dangers lurking within? Investment management consultant MATTHEW FEARGRIEVE explains why would-be homeowners need to proceed with caution.

A new Help to Buy equity loan scheme is now (beginning April 2021) available to first time buyers who have a deposit of 5% to put down.

Rather than taking out a mortgage for the remaining 95% of the property value, you could take advantage of a government loan of 20% of the property price, so you would only need a mortgage for the remaining 75%.

If you’re trying to buy a property in pricey London (good luck with that), the government will lend you up to 40% of the property price. Once your 5% deposit is factored in, that means you will need a mortgage for 55% of the property value.

Any loan is capped on new-builds at the level of newly-fixed regional price caps that reflect differences in property valuations in different parts of the country.

The government loan is interest-free for the first five years. After that, you pay a monthly interest fee of 1.75% of the equity loan. The interest rate will rise each year in April by the Consumer Price Index (CPI) measure of inflation, plus 1%. Even if the RPI falls, the equity loan portion of the mortgage will still attract a loan fee of at least 1%.

The loan will have to be repaid in full (plus interest) when your property is sold, or at the end of your mortgage term, whichever happens first. If you want to pay back some or all of the loan early, the minimum repayment you can make is 10% of the property’s current value.

You’ll need to pay to have the property independently valued by a surveyor to work out how much you’ll need to repay. There may also be an administration fee to pay, usually around £200 which is payable when you pay back some or part of your Help to Buy equity loan.

The loan can only be used to buy your main home, and not a Buy to Let property.

These rules only apply to properties in England. Wales, Scotland and Northern Ireland have similar schemes.

The new scheme will finish in March 2023 and to date no further equity loan scheme has been announced.

So, first-time buyers, it all sounds great, doesn’t it? Well, not quite. Beware of the dangers lurking underneath the glossy and appealing surface of the scheme. Here is a summary of the downsides and pitfalls you need to be aware of.

First and Foremost: this is a government scheme. This means that there are economic and political considerations at play being the scenes. Governments are keen to win votes and popular schemes like this one, just like the furlough schemes and the Help to Eat Out scheme (remember that?), are inevitably designed to be vote-winners.

They are also designed, like the stamp duty holiday, to prop up the UK property market: and by extension a post-pandemic economic recovery.

This necessarily doesn’t mean that the scheme is right for you. You need to make sure that you, personally, after carefully considering your own financial and employment situation, can afford to borrow large amounts of money that you might not in future be able to repay (and don’t forget the interest charged in addition).

Remember, this “Help” is a still a Debt. The money the government lends you will have to be repaid. And, just like any lending on property, if you can’t keep up with the repayments, you may lose your home. True, the government is lending you one-fifth of the purchase price (two-fifths if you are buying in London). You are stumping up at least 5% of your own money.

That leaves most of the purchase price (55% to 75%), which still needs to come from someone or somewhere, and for most first time buyers, these means a commercial lender: a bank or building society will lend you that money, in the form of a mortgage.

That mortgage – just like the government loan – will need to be repaid.

Remember, home “ownership” is an illusion for the vast majority of first time buyers (and, indeed for most other homebuyers), because the lender will own most of your home until it has been repaid. So, whilst shipping out of your parents’ home, or moving out of rental accommodation, may seem attractive, you should guard against fooling yourself into believing that you are transitioning to “home ownership”. For most users of the government’s scheme, they will own 5% of their home, and not more. The other 95% will be owned by the lenders, who can evict you if you can’t pay them.

Sounds a bit like renting, doesn’t it? Only the financial and emotional cost to you will be far, far greater than renting. Don’t be in a hurry to turn your back on renting.

Can you truly afford the lending? Having understood that you will not truly “own” the property that you are acquiring, the next psychological adjustment to make is an important one. Don’t ask yourself if you can afford to buy. Instead, ask yourself if you can afford the repayment terms of the borrowing you are taking on.

Is this really the right time to borrow? At the end of the day, and maybe in return for just 5% of the property, you will be taking on a large mortgage debt (and maybe using up your savings to stump up the deposit) at a time of unprecedented economic problems (present and pending) when (a) the terms of mortgage lending and (b) job and income security, are at their most unstable.

Read our 2021 forecast for UK Property Prices by clicking here.

Read our opinion Why UK House Prices are headed for a Cliff Edge by clicking here.

You might find you needed the savings you have sunk into the deposit, just to meet your living costs. You might find, as furlough schemes end and employers start to get back to “normal” this summer/autumn, that your job/income is not as secure as you thought. Even if it is, your mortgage lender’s opinion of your attractiveness as a debtor may change, and you could find yourself with lending withdrawn or with significantly higher monthly repayments.

Don’t let the Scheme be the only reason for wanting to buy. Sure, 20% is a very helpful chunk of the money you need to secure a property to make your home. But the government scheme shouldn’t be the only, or main, reason why you want, at this moment in time, to buy a home.

You should want to buy because you believe that the time is truly right for you to transition out of Mum and Dad’s place, or rental accommodation, and into the serious business of paying a mortgage (and the government; two lenders). You should have done all your homework and financial planning, all the maths and the calculations, taken into account all the risks (unemployment, recession, illness etc) and have concluded that you really can afford to repay the money you are going to be borrowing.

What about Property Prices? So, you’ve put to one side the government scheme, and you have worked out (after doing your homework) that you can afford the borrowing that you want to take on. The next thing to consider is property prices. Is now a good time to enter the UK property market?

This is where we can’t help you. No one has the crystal ball that will enable us to see what direction property prices will take over the coming months. But we can give you some pointers that you might like to keep in mind as you wonder whether that property is really worth the asking price, and all that money you are going to have to borrow…

Yes, you would be buying in a high market if you were to complete a purchase right now. If you had an offer agreed now, it is questionable whether it would complete before the end of the stamp duty holiday on 30 June. If it completed, say, on 1 July, you would have additional stamp duty to pay. (So don’t let the stamp duty holiday be the main thing driving you to buy, either).

It might be more sensible to keep an eye on the market, but took a cooler approach and wait to see what happens to prices post-30 June. As “normality” and economic issues creep in, you might find a decrease in prices in the autumn and in 2022. This is our personal forecast, shared by some and not shared by others. Nobody really knows. But our opinion is that UK House Prices are headed for a Cliff Edge.

Don’t, though, expect a massive drop in prices this year or next. We believe that the property market, like the stock market, is sustained a lot by hope, emotion and - most of all - greed (in other words, short-term profit taking by interested parties: banks, estate agents, sellers). These factors, whilst disagreeable, do indeed motor the property market, just like they motor the stock market.

Read our 2021 forecast for UK Property Prices by clicking here.

You might also like to keep an eye on inflation forecasts. In an inflationary price scenario, the value of your Pound goes down. Infrastructure and construction, like everything else, becomes more expensive, and this cost is passed on to house buyers, in the form of higher prices. Opinion right now is very divided about whether inflation will come into play this year or next – if at all. Don’t stress about inflation too much, but keep it in mind when you are thinking about possible future price movements.

On the other hand, don’t worry about prices going down after you have bought. Looking back at the UK property market over the last three decades, we believe that it will increase in value over time, with a few “blips” in between. Consider the high level of buying that has gone on during the stamp duty holiday. Most of this activity has been motored by people who, having bought twelve, fifteen, twenty or more years ago, find themselves “property rich” – the value of their home(s) has increased so much, relative to the purchase price, that they feel empowered to borrow on the value of their homes and buy some more. The UK property market has been, on the whole and in many parts of the UK, a good long-term investment.

Be wary of advice from older homeowners. Particularly mum and dad, or other family members, who offer you positive encouragement to “get your foot on the ladder”. Committing to the lending that a property purchase entails has to make financial sense for you. If it doesn’t make sense, it doesn’t make sense. That doesn’t mean that it won’t make sense for you at some future time. Don't rush into it.

And remember, times were very different when older homeowners bought their first home. Their advice needs to be evaluated, not blindly accepted as the wisdom of older, more experienced people.

In conclusion…

Have we managed to dissuade you from even trying to buy your first home? Well, we did not set out to do that! This article is designed to encourage you to think carefully before taking the leap into home ownership (with or without the government's help).

We leave you with these final thoughts, as we wish you luck on your journey:

1. Make sure that you can afford any repayments entailed by any government scheme in the event that they accelerate the repayment schedule, or demand repayment. You never know what the government may be forced to do, post-pandemic (always assuming that we are actually coming out of it, which is not yet certain).

2. Make sure you can afford – truly afford – any purchase monies you borrow from a commercial lender (bank, building society). Ask yourself whether you could afford to pay more per month in the event that they accelerate the payment schedule or – worse – withdraw the lending deal you signed up to, if your circumstances change (or their opinion of your personal circumstances changes).

3. Do not rush to buy just because of the availability of the government scheme. If you can’t truly afford the borrowing, then keep away. Bide your time.

4. If the lending you need to take on is affordable, even if the lender changes the repayment and/or interest terms, or later withdraws or significantly modifies what you signed up for, then don’t worry about future blips in the property market value. Having a stake in your own home (if you can afford the borrowing entailed) is always better than paying someone else a rent.

5. Think twice before turning your back on renting. It is a tenant’s market right now, in many parts of the country, and there are deals to be done with landlords on rent.

6. Consider your job prospects over the next three years. Is your income as secure and sustainable as you think it is?

7. Think about your age. We receive anxious emails from people in their early twenties, some of whom have barely left their parents’ home, or are still in it. Don’t obsess about home “ownership” when you should be having fun (without overspending!). Someone in their twenties (and, we would say, thirties) has plenty of time to save money with a view to getting onto the property ladder. And there is a certain liberty in renting, because it is a significantly less onerous responsibility than paying a mortgage (and/or the government).

8. When comparing renting to buying, always remember that true home “ownership” is an illusion for most first-time buyers. If you need a mortgage, the bank will own most of your home, and will do, in most people’s cases, for years. This brings you back to carefully considering, as unemotionally as possible, whether you can really afford that mortgage on the terms offered. Mortgage lending can be liberating. It can also make your life a misery if you can’t keep up with the repayment demands. The same goes for the government loan. You can read more about the dangers of he illusion of home ownership in our earlier blog here.

9. Try to remain unemotional. We all fall in love with a property. But don’t let love blind you. And don’t let love (or your ego) lead you to buy something bigger and/or more expensive than what you really need/can afford.

10. Beware the advice of older family members and homeowners egging you on to “buy” and “get your foot on the property ladder”. The step has to make financial sense for you. If it doesn’t – then you carry on living at home, or in rental accommodation. Bide your time. If you're in your twenties or thirties, time is something you still have; when it comes to buying property, that is.

Read our 2021 forecast for UK Property Prices by clicking here.

Read our opinion Why UK House Prices are headed for a Cliff Edge by clicking here.

MATTHEW FEARGRIEVE is an investment management consultant. You can read his property blog here and his Twitter feed here.

Matthew Feargrieve, investment management consultant

IMPORTANT: the views stated in this article are the author’s opinion only, and are not intended to be relied on as advice, for which you should rely on your own professional advisers.