What is the Help to Buy Equity Loan?
The Help to Buy Equity Loan
was brought in to enable people with a lower deposit to get on the property ladder. With a 5-10% deposit, buyers could purchase a new build property with a 20% loan from the government to make up the difference (40% in London). They would then get a mortgage for the remainder of the property value.
The 20% equity loan was interest free for the first 5 years of living in the property – at the end of the 5 years, interest is set at 1.75% and will rise in line with Retail Price Index plus 1% year on year.
For many, paying this interest on top of their mortgage, especially as it increases, is problematic. So what can you do?
- Pay the interest – the first option is that if you’ve accounted for the interest kicking in after 5 years, and you intend to stay in your home for quite a few more years, you have been saving up that money to pay the interest off. However, with the interest continuing to climb the longer you stay in the property, this is really only a short term solution, and may not be the best use of your savings.
- Pay off the equity loan – you may have used those 5 years to save up in order to pay off the loan itself. Depending on how big a loan you took out, this may or may not be possible. The unfortunate thing about this is that you cannot pay off the loan in increments – you can either pay half of it, or the whole of it. In order to pay off the loan, you will need to get a property valuation, as the amount you owe will be determined by your current property value, NOT the value of the property when you bought it. The valuation is another cost that needs to be accounted for.
- Sell the house – Many people signing up for the scheme seemed to think they would live in the property for 5 years, then sell up when the interest kicked in. In some cases, this is an excellent idea, especially in the south where property values have increased (although bear in mind that this would also mean the equity loan amount has increased). The problem comes in places where property has not grown in value – you will need to pay back the equity loan from the sale, and after 5 years of paying off your mortgage you may end up with low or negative equity. In some scenarios owners would not have enough money to form a decent deposit to move, and so would have to stay and pay the interest, or sell at a loss.
- Remortgage – whilst there are quite a few Help to Buy mortgage lenders out there, there are not many who deal with remortgaging on the scheme. The four banks who currently do offer a remortgage require you to have 10% equity in your home, not including your original deposit. If you are planning to remortgage in order to cover the equity loan, the best thing you can do in the first 5 interest-free years is to overpay as much of the mortgage as you can. This will give you a better rate when it comes to remortgaging. Bear in mind there will be fees associated with remortgaging and possibly with overpaying.
What are the main problems?
- The equity loan interest payments will only increase year on year, cutting into your ability to save to pay off the loan. Taking a long term view and accounting for these costs rather than burying your head in the sand is the best course of action.
- Lower cost areas where property values have not increased can leave the buyer with negative equity, or not enough of a deposit to sell up and move out.
- You can only pay off the equity loan either in halves, or the total amount (in Scotland, you can pay off in quarters).
- Remortgaging options are currently slim.
What is the best thing to do?
This really is dependent on the location of your property, how much it has increased in value, whether you want to move again, or can afford to.
The main question, however, is were you making the most of those interest-free 5 years?
The most straightforward answer, and the goal of the scheme in general, was that the buyer uses those first 5 interest-free years to save enough to pay off the equity loan. By steadily saving over 5 years, many people could afford to save up to pay the loan back, even with a mortgage to pay.
However – what if you live in an area where the property has significantly increased in value?
That 20% loan may have skyrocketed beyond your expectations, and it may not be possible to pay it off. So what should you do then?
If your property has increased in value significantly and selling it would yield a good deposit to upsize, you would avoid having to pay the interest on the equity loan. This might be the first option.
If you have a lump sum saved, but you don’t have enough to pay off the equity loan in its entirety, you have a couple of options – if you have enough, you could pay off half the equity loan, or you could put that chunk towards your mortgage.
If you live in an area where the property has not really increased in value, moving is not likely to be an option, and waiting in the hopes that your property will increase in value longer term may be the better option. But what do you do in the mean time?
Paying off the equity loan or the mortgage?
Currently opinion is split about whether to pay off the equity loan or pay towards the mortgage, if you have saved a lump sum up during those 5 interest-free years.
If you have the ability to pay of the whole of the equity loan, then you’ll avoid paying the interest on it over the next few years. Do the maths on how much you will end up paying year on year and see whether this is the best option. Similarly, you could pay off half of the equity loan, and your interest would decrease considerably.
However, in some cases, if you are intending on selling your property fairly soon, it may be worth paying off more of your mortgage so that you own a bigger portion of the property. This would get you a better rate on a remortgage, and when selling, would ensure you had a bigger deposit available to move on.
The choice of which to pay off comes down to how much you have saved, how much you can continue to save, and whether your mortgage lender will let you overpay.
What other costs should I be aware of?
Depending on how much of an equity loan you took out, that extra interest
may make a difference to your outgoings if it goes ignored over the years as it increases. Have a plan to pay the interest if you are planning on staying in your Help to Buy property long term. You may have crunched the numbers on how much interest you will pay until you decide to sell and it may remain a good deal.
If you decide to pay off the equity loan, you’ll need to pay for a valuation of the property and conveyancing costs to transfer that portion of the property into your name. If you pay off the loan in two chunks instead of one, you’ll have to pay again for a valuation and conveyancing.
If you decide to pay a larger chunk off your mortgage, you’ll have to check whether overpaying is allowed by your provider, and if there’s an upper limit. If you can’t pay it off as a chunk you may be able to increase your monthly mortgage payments. Changing your lender agreement may incur fees.
If you decide to remortgage to get a better deal, you may also face fees.
Leasehold ground rents
For those who bought leasehold flats under Help to Buy, they may face an increase in the ground rents, with some of them even doubling each year. This will make resale difficult. If you expect your ground rent to increase, be aware of this cost going forward, and the effect on a future sale.
The Help to Buy Equity Scheme has helped many people get onto the property ladder who may not otherwise have been able to but creating a plan of attack when it comes to dealing with debt and interest is key.
Those who took advantage of the interest-free 5 years in their home by saving as much as possible will be in a good position to either make a dent in the equity loan, mortgage or cover their interest fees over the next few years.
Two main things affect how you deal with the end of your interest-free period with Help to Buy – whether you plan to stay in the property long term, and whether the value of your property has increased at all. Have a chat with your mortgage advisor, and make sure you work out how much that interest could build up to over the next few years. No matter what, always have a plan for paying off your debt long term.