Borrowers who took out a Help to Buy Equity Loan when it first launched will be reaching the end of their five-year interest-free periods. Here's what they should do next...
By Esther ShawDecember 11, 2018 00:00
What is the Help to Buy Equity Loan?
A quick recap. It was introduced by the Government to help buyers with small deposits get on to the proper ladder.
With the Help to Buy Equity Loan, buyers only need a 5% deposit, but it must be a new-build property worth less than £600,000 in England, £300,000 in Wales or £200,000 in Scotland.
If you can save a minimum of 5%, the Government will lend you up to 20% of the value of the property (up to 40% in London and up to 15% in Scotland).
There is no interest to pay on the 20% loan for the first five years, although there is a £12 annual management fee, and you take out a mortgage on the remaining 75% of the property’s value. The loan itself is repayable after 25 years or on sale of the property if earlier.
Read our guide to all the Government's home-buying schemes.
What happens when the five-year period comes to an end?
This is when the interest kicks in for the 20% Equity Loan and repayments rise, unless you have bought in Scotland.
“First-time buyers should be aware of the Ts and Cs of the loan,” says Craig Hall, mortgage expert at the Legal & General Mortgage Club. “It is fully stated at the outset, and in each borrower’s annual statement, so there should be no shocks.”
The Equity Loan interest payments are calculated at the time he property was purchased and are not affected by changes to the property’s value.
The interest rate on Equity Loan repayments starts at 1.75%, with the annual interest linked to the RPI index, plus 1%.
“This means the interest rate will move over time. But is a typical market rate,” says James Chidgey, new homes manager at Mortgage Advice Bureau.
Are lenders factoring in the additional risk of lending to buyers who are using the Help to Buy Equity Loan?
Yes. Affordability rules of mortgage regulation mean lenders must consider what might happen after the interest-free five-year period.
Chidgey says: “Lenders tend to have separate product suites for those who are purchasing under Help to Buy and these specific mortgages have slightly different rates to allow for the Government’s second charge on the property.”
The question is whether it will be more expensive.
For example, Barclays currently offers a two-year fixed rate mortgage for 75% loan to value at 1.59% with a product fee of £999.
Its Help to Buy two-year fixed rate mortgage for 75% loan to value is a higher 1.67% but has a slightly lower product fee of £749.
In this instance, if the mortgage was £300,000, the lower arrangement fee would not quite offset the higher interest rate and the two-year fixed rate Help to Buy loan would work out £230 more expensive.
Does this mean first-time buyers receive a raw deal?
While the above example shows a premium to a specific Help to Buy mortgage product, Mark Harris from mortgage broker, SPF Private Clients says: “Many of the first-timers who have used the Help to Buy Equity Loan wouldn’t have been able to buy at all without Help to Buy. While the scheme is not perfect, it certainly isn’t a raw deal.”
Does the Government have plans to extend the interest-free period?
No, but the Government has extended the availability of the scheme from 2021 to 2023.
If you’re a first-time buyer coming to the end of your five-year interest free period, what should you do?
Give yourself time to assess your finances and explore the following options:
1. Start paying interest on the loan.
As well as your monthly mortgage repayments (ie. for the 75% loan to value mortgage), you will now also pay interest on your Equity Loan at the current rate (ie. 1.75%).
You won’t pay off any of the Equity Loan capital, but in servicing this second loan, your monthly outgoings will increase.
2. Find a better rate for your mortgage.
It’s always good practice to shop around, but given your Equity Loan interest payments will start to kick in, see if you can get a better deal on your mortgage.
If your property has increased in value, you will effectively own a higher portion of it outright, and this should give lenders more faith to offer you a better deal.
Some lenders will not allow borrowers to switch from a Help to Buy mortgage to one of their traditional deals, so you may have to change lenders.
This option will also not reduce the outstanding balance on your Equity Loan. The Equity Loan is still worth 20% of the value of your property, whether the overall value has risen or fallen.
3. Re-mortgage and use the capital to pay down your Equity Loan.
If your property has risen in value you may be able to re-mortgage, as above, and pay off a chunk of the Equity Loan. This option is known as staircasing.
For example, you paid £400,000 for the property, with a £20,000 deposit, £80,000 Equity Loan and £300,000 mortgage (at 75% loan to value).
If the property’s value rises to £500,000, then a new 75% loan to value mortgage would allow you to borrow £375,000.
Unfortunately, because of the increase in value of your property, the 20% Equity Loan will have also risen to £100,000. ie. the Government still owns 20% of your house.
But you could still use £50,000 of the new mortgage to pay off half the existing Equity Loan (the minimum you can 'staircase' is 10% of the property's price), reducing it from £100,000 to £50,000.
4. Sell your home and move house
If you’re looking to move, you will have to pay back the Equity Loan because you cannot port it to another property. But there is a sting in the tail here because you are required to pay back 20% of the sale price.
For example, if the property has risen from £400,000 to £500,000, you owe £100,000 - £20,000 more than the original £80,000 Equity Loan.
Similarly, if the property falls in price, you will pay back less, although this is not an ideal situation given you still have a mortgage to pay.
As there are many options to consider and your financial circumstances may well have changed in the five years since you bought your home, it is worth seeking advice.
A broker will be able to provide a holistic view of what is possible, and can help you find the right products for your needs. You can also compare thousands of mortgages with Zoopla’s partner, Money.co.uk.
Top tip: Start planning
As a borrower, you may not be aware that you can ‘book’ your next mortgage up to six months in advance with some lenders. This can save you a significant amount of money.
To ensure you will be eligible for the most competitive rates, it is important to get your finances in order before applying for a remortgage.
This includes paying down debts, such as credit cards, personal loans and outstanding finance agreements – or clearing them completely.
You should also check your credit rating, and take steps to boost your credit score before you start the remortgage process. That way, you are giving yourself the best chance of success.
You might also be interested in...
- The Government's homebuying schemes explained
- 9 ways you can help your child get on to the property ladder
- 10 pros and cons of the Help to Buy ISA
- The lengths first-time buyers will go to save for a deposit