The true cost of ‘Help to Buy’ – is it just a Government con?Make Text Bigger
An article by Alex Caravello – MK Landlords Association
Is Help to Buy just a Government con?
To answer this question I thought I’d compare the true cost of the ‘Help to Buy Equity Loan’ scheme with the cost of renting a similar property long term.
The ‘Help to Buy Equity Loan’ scheme only applies to new build properties. Typically, new build properties come at a premium of as much as 25% compared to similar second hand property. For this example we will assume the premium is only 20%. It is therefore in the buyer’s interest that house prices increase by at least 20% before they sell, otherwise they would be in negative equity.
This Government classifies ‘Affordable Housing’ as housing costing £250,000 outside of London (within London this figure increases to £400,000). We will therefore use the figure of £250,000 in this example.
New build property does not usually come with carpets, curtains, garden landscaping, etc and the capital cost of supplying these would typically be in the region of £5,000 plus.
One criterion of Help to Buy is that the buyer must put down at least a 5% deposit. The Government will then provide an equity loan of up to 20% and the buyer must be able to qualify for a mortgage of at least 75%.
For the purposes of comparing like-for-like, let’s assume that the 5% deposit is also borrowed at typical mortgage rates. It could be borrowed from the Bank of Mum and Dad as equity withdrawal from their own home mortgage and would therefore cost the typical mortgage interest rate.
The Help to Buy Equity Loan means that that the Government has a 20% stake in your property. If the value of the property goes up (which you need to avoid negative equity), then the equity loan goes up too, meaning that you will repay more than the original loan amount. Typical long term house price growth over the last 25 years (the typical mortgage term) has been over 250%, meaning that the original 20% equity loan will increase to the equivalent of 50% of the original purchase price over 25 years.
The equity loan is interest free for the first 5 years, then interest is payable at 1.75%, increasing annually by RPI + 1%. Current forecasts are for the RPI to be at 3.3% by 2021. This means that, if you took out a Help to Buy Equity Loan today, when the interest starts to become payable you would be paying interest on the equity loan of 1.75%, rising to 4.06% in the twentieth year, thereby an average of 2.91% over the remaining 20 year term. This is in addition to the (potential and necessary to avoid negative equity) rise in the value of the equity loan explained above.
Typical 25 year fixed mortgage rates are around 5.5%, with £1,000 mortgage arrangement fees. For the purposes of this example we will ignore any redemption penalties that would be payable to change to a different mortgage, or if the house is sold before the mortgage is repaid. A buyer typically also pays another £1,000 for solicitor’s fees, disbursements and valuation fees. Stamp duty is currently 2% from £125,000 to £250,000, so in this example would be £2,500.
Maintenance and repair costs are the responsibility of the home owner, as is buildings insurance. Typical costs vary, but a long term cost of around 1% of the original purchase price per year is typical. However, for the purposes of this example we will assume only 0.5%, as hopefully a new build property will suffer from a lower level of maintenance and repair costs than a second hand property (this is not necessarily true, but is an adequate assumption for illustrative purposes).
COST OF BUYING
What is true cost of buying a £250,000 new build home with a Help to Buy Equity Loan?
Stamp duty £2,500
Solicitor and survey fees £1,000
Mortgage arrangement fees £1,000
Carpets, curtains, garden landscaping, etc £5,000
5% deposit £12,500
Total capital required £22,000
Interest on capital costs over 25 years £30,250 (typical loan interest of 5.5%)
Help To Buy Equity Loan Costs
Original 20% equity loan £50,000
Actual equity loan to repay over 25 years £125,000 (assuming 250% house price growth)
Interest on equity loan over 20 years £29,100 (assuming average 2.91% interest rate)
Original 75% mortgage £187,500
Interest on mortgage over 25 years £258,000 (assuming 5.5% fixed interest rate)
Maintenance, Repair & Insurance Costs
25 year cost £31,250 (assuming 0.5% of original price)
TOTAL COST OF BUYING £683,100 (equates to £2,277 per month)
COST OF RENTING
The £250,000 new build home comes with a 20% premium; therefore a similar second hand property would be worth £208,000. Typical rental yields in the South East of England (excluding London) are around 5%, which equates to a monthly rent of £870. Assuming rents increase by the average 3.3% RPI used above, then a typical tenant would pay £424,000 in rent over 25 years.
A tenant does not need to spend anywhere near the same level of capital to rent a house compared to buying (say, £1,500 for a deposit and administration costs versus £22,000 to buy – and the deposit is returnable at the end of the tenancy).
Therefore, the true cost difference between buying a £250,000 new build home with a Help to Buy Equity Loan and renting a similar second hand property is £259,100 more over 25 years.
Yes, the advantage is that you would own your home after 25 years, but at an extra cost of £259,100. This is all well and good, if you can afford to buy, but if not, why should renting – and saving £259,100 over 25 years – be seen as second best?
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