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Struggling with deposit? New buy scheme announced

New scheme announced to help buyers struggling to raise a deposit

Last week, the government announced a mortgage indemnity scheme to help FTBs get onto the property ladder and existing homeowners to climb up the ladder. In other words, the government are trying to kick-start the economy by bypassing the need to save a 10% or larger deposit, by encouraging mortgage lenders to provide mortgages with a high loan to value of 95%.

The main points are as follows:

a. Only applies to new builds b. Only applies to properties bought for up to £500,000 c. The buyer must be a UK resident d. The scheme is secured by both builders and the government (tax payer) e. Buyer puts up 5% f. Builder deposits 3.5% of sale price with lender for 7 years (after which returned with interest/less losses) g. Government guarantees extra 5.5% which will be used to compensate lenders if repossession is necessary

In other words, if the homeowner can no longer pay their mortgage and the home has to be repossessed and sold for less than the mortgage value, the government’s guarantee will be called up to compensate the mortgage lender. So, worst case scenario, the tax-payer coughs up. But the homeowner will still be liable to repay the entire outstanding mortgage including the 9% of the sale price (3.5% + 5.5%) that the lender was able to reclaim to cover the first tranche of its loss.

I foresee a number of problems. Interest rates are at their lowest and have to go up at some stage. Given that some of the deals being offered under this scheme by mortgage lenders are for a fixed period of 2 years, the buyer could well face inflated monthly mortgage payments once interest rates start to climb. Problem – interest rates are low, so as they rise buyers may struggle. In my view, the solution to this problem would be to offer a much longer fixed period, of say 10 years, to give the buyers a fighting chance of being able to keep up with their mortgage payments in the medium to long term.

For a number of reasons this scheme can only apply to new builds. The problem with that is that, not only are new builds more expensive than re-sale homes, they usually command a premium price, which means that on average about 5% of the property’s value is wiped off as soon as the buyer moves in. And surely buyers struggling to buy in the first place should be buying the less expensive re-sale homes? This last point strikes a chord with the views of some who argue that the government is simply trying to help builders out.

On the other hand, to be fair to the government, there are limited options available to them given the country’s deficit, so they are desperately trying to find ways to boost the country’s economy, and it is true to say that the state of the property market has a huge impact on so many sectors and industries, including building of course, so such a scheme could have a very positive effect.

Others feel that is simply an attempt to stop property prices dropping further. The counter argument to this is that we should let prices fall, to make homes more affordable. After all, should people be buying with a 5% deposit simply because such a scheme enable them to? Let’s face it, we have discovered over the last few years the risks posed by leveraging.

My advice to buyers? I understand your desire to own a home, or to upsize. Rents are currently high, so for some buying might actually be the better option. If you are going to buy, please follow these golden rules:

  • The implementation of the scheme appears somewhat messy as not all major builders and lenders on board, so tread carefully, particularly if you want to part-exchange your existing property.

  • Seek independent financial and mortgage advice from a good independent financial adviser

  • When considering your monthly mortgage payment, leave plenty of headroom for when interest rates do eventually increase.

  • Don’t overstretch yourself. It’s not worth the risk. Be sensible, you can always upsize in a few years’ time.

  • Negotiate very hard with the builder or estate agent marketing the property, and consider using a 3rd party to negotiate on your behalf.

Oliver Hudson 12th March 2012

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