The credit crunch has had a major impact on house builders. The steady supply of purchasers, armed with their 95, 97 and 100% mortgages, has dried up while mortgage lenders have all but withdrawn completely from the new build market after so many had their fingers burned as house prices tumbled in the latter part 2007 and through 2008. Applicants purchasing new homes often have to raise a larger deposit than those purchasing on the second hand market; new build flats usually require an even larger deposit than houses, such was the sharp decline in values seen in many city centre developments dominated by flats.
In order to bring punters through the sales office door, house builders needed a way to circumvent the lending problems faced by many buyers. They turned to shared equity schemes, once the preserve of housing associations but now a fundamental part of every major house builders’ marketing strategy. Essentially, a shared equity scheme allows a person (usually a first time buyer) to purchase a property and have 100% of the ownership, by only paying part of the sale price, say 80%. The remaining 20% is contributed by the housing association, builder or other interested party. The 20% stake is in the form of a loan, repayable after a certain period of time, or if the property is sold. The key thing here is that it allows purchasers to buy a house on a 75% loan-to-value mortgage deal while only contributing a 5% deposit themselves. Almost every house builder now offers these schemes: Barratt Homes have Head Start; Linden Homes have Easy Start; Taylor Wimpey also have Easy Start (Linden must have forgotten to copyright the name); while Bovis offer Jump Start. That’s quite enough ‘Starts’ for me. For the purchaser, this represents a great way of buying the home they want at a reduced price.
Let’s look at a real-life example. Last week I valued a property being purchased by two first time buyers, let’s call them Mr Smith and Ms Jones. They bought a 3 bedroom mid-terrace townhouse. The agreed sale price was £240,000, but our happy couple only had to put £12,000 (5%) towards the deposit. The other 20% (£48,000) needed to reach the 25% total deposit that the mortgage lender required was given to them in the form of a loan by the house builder. The builder’s loan is repayable within 10 years and will be 20% of the value of the property at that time.
So how are Mr Smith and Ms Jones going to repay their loan?
There are 3 main options:
1) Save
They could put a certain amount aside each month in order to repay the loan at the end of the ten year term, or repay it in monthly instalments. But in order to reach their £48,000 target, they would need to save £400 every month for ten years. Most first time buyers are young, often in couples, and within ten years they are likely to have children to support, and mum will probably have given up work to look after the kids. So that’s £400 per month that needs saving, on top of a mortgage, household bills, children to feed, only one working parent and, thanks to university tuition fees, a huge student debt to service. Given that they weren’t capable of saving for a deposit in the first place, squirreling aside £400 per month once they own a home simply isn’t going to happen.
2) Remortgage
Although no one actually spells this out, shared equity schemes rely on rising house prices. If values increase, owners can remortgage their properties and use the equity to repay their loans. This is all well and good if prices rise but it won’t work if prices fall or remain static.
3) Sell
So the ten years comes to an end and a bill arrives for £48,000. Smith & Jones can’t pay it because they haven’t been saving any money and they can’t borrow more money because the stagnant economy (look how long it took Japan to get out of their last recession) means that house prices haven’t increased. So they have no option but to sell. They might achieve around £240,000 if they are lucky, but as people often overpay for new homes (because of the premium attached to living in a new house), in a static market they may even see a loss. Either way, they are out of their home and back at square one; unable to purchase a property unless it is through a shared equity scheme.
So the central premise to all shared equity schemes is the old adage ‘house prices always rise’. Which they do. Unless they are falling or static. In which case the shared equity loan becomes a millstone around the necks of the homeowner and shared equity partner.
So with these clear risks attached to shared equity schemes, what advice does the government have for would-be first time buyers? Go for it! In fact, the government has just launched its FirstBuy product which, like the schemes offered by house builders, allows purchasers to borrow 20% of the purchase price, but over a 25 year period. But, unlike some of the house builders’ schemes, FirstBuy starts to charge interest on loans after 5 years. The FirstBuy brochure describes this as a ‘low’ rate of interest; 1.75% in year 6, rising by RPI+1% each year. The trouble is that RPI is currently running at 5.2%, giving a total rise of 6.2% per annum - not exactly what I would call ‘low’ and not far short of rates for unsecured personal loans. Assuming a more ‘normal’ RPI of 2% (although what counts as ‘normal’ nowadays is anyone’s guess) plus the 1% add-on, Smith & Jones’ loan of £48,000 would have increased to nearly £56,000 by year ten. Which means they would need to save over £460 every month for ten years in order to repay it. Or hope that for an even greater increase in house prices than they needed when they only had a £48,000 loan so that they can remortgage their way out of debt.
As a valuer, it is not my duty to give financial advice. When valuing Mr Smith and Ms Jones’ future home for the mortgage lender, I have no obligation to point out the potential financial risks that they are taking. But I do feel that there is a moral obligation for someone, somewhere to explain the pros and cons of shared equity schemes in detail. I do not believe that all first time buyers taking out equity loans are naive, but there must be a good portion who think ‘great, I can buy a £240,000 house for only £12,000. Bargain!’. Ten years must seem like a lifetime away amidst the excitement of owning your own home, and even if they are concerned that they won’t be able to save enough money to repay the loan, there is always the ‘house prices always rise’ line to reassure themselves. No provision is made in any of these schemes for repaying monthly (as with student loans, for example) because apparently rising house prices will take care of things. To me, this represents a return to the pre-credit crunch debt-driven culture of risk-taking and financial irresponsibility. Taking a large loan with the intention of using rising house prices to repay it can be a recipe for disaster, as so many people and institutions found out a few years ago. Am I the only one who has raised doubts about these schemes? I know that most of my colleagues are also uneasy about them and it would appear that most mortgage lenders are too; of the mainstream lenders, only Halifax and Nationwide will lend on properties bought through shared equity schemes. If the credit crunch has taught us anything it is that caution and clear thinking should underpin every financial decision. Looking at the risks associated with shared equity schemes, it would be hard to recommend them to anyone.
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