Many commentators argue the government’s Help to Buy scheme will inflate a price bubble because supply will not respond to the demand boost. John Stewart explores the design of the two Help to Buy schemes in detail and their likely impact on demand and supply. He believes supply will respond to the increase in Equity Loan demand for new homes, and that the net impact of the Mortgage Guarantee scheme will be considerably less than the total number of loans granted under the scheme.
The government is clearly concerned by the economy’s failure to achieve a sustained recovery. It accepts that capital spending on infrastructure, including housing, could be an important source of growth. The two Help to Buy (HtB) schemes are intended to revive private home building and put life back into the housing market. Both schemes are designed to bridge the deposit gap, with the Equity Loan scheme also helping to make new home purchase considerably more affordable. Both are temporary three-year schemes, the Equity Loan running from April 2013, the Mortgage Guarantee from January 2014.
In his 2013 Budget speech, the Chancellor gave several reasons for launching HtB: meeting people’s aspiration to own a home, support for home builders and a “dramatic intervention to get our housing market moving”. CML data show the median first-time buyer loan-to-value (LTV) hovered close to 95% from 1982 to 1998, so 95% loans are neither new nor a threat to market stability. In its Mortgage Guarantee Scheme Outline, the Treasury says it is the “Government’s view that the current scarcity of high loan-to-value lending is primarily a cyclical issue rather than a symptom of a longer-term structural change in the mortgage market”. This should reassure Mervyn King (Sky News Interview, 19 May 2013) that HtB will not become permanent.
HtB: Equity Loan
The Equity Loan scheme is for new build homes in England up to £600,000, although funds were made available for the other countries of the UK and the Welsh and Scottish governments are looking at introducing their own versions. Buyers must have a deposit of at least 5% and the government will make a second-charge loan of 10-20% of the sales value, so that mortgage rates tend to reflect rates for 75% LTV loans rather than 95% loans. The house builder is not required to leave any equity in the property, making the scheme especially attractive to smaller house builders compared with earlier equity loan schemes like FirstBuy.
The Treasury expects 74,000 Equity Loan sales over the three years of the scheme. Its £3.5bn investment could generate new home sales of as much as £17.5bn. However the net impact will be less. House builders were already achieving significant sales under FirstBuy. The Equity Loan scheme will replace and expand on FirstBuy. The scheme will also replace some sales that would previously have been made under the NewBuy indemnity scheme. To put the scheme in context, in 2012 the private sector started 78,660 new homes in England and completed 88,860. The Home Builders Federation (HBF) has recorded around 4,000 Equity Loan reservations in the first two months, a very strong start, and the Homes and Communities Agency (HCA) has processed around 400 builder registrations, four times as many as offered FirstBuy.
HtB: Mortgage Guarantee
The Mortgage Guarantee scheme will, in theory at least, apply to new and second-hand properties up to £600,000 across the UK. However it is voluntary for lenders so not all will participate and at least one (Nationwide) has said it will probably require new home buyers to use the NewBuy scheme. The government will guarantee a portion of any lender repossession losses for up to seven years. Home buyers will require a deposit of at least 5%. The lenders will apply their normal 95% LTV affordability and credit scoring criteria so there should be no risk of any relaxation of lending standards.
The Treasury’s working assumption is around 190,000 transactions per year, with mortgages valued at £130bn over the three years. To put this in context, 610,000 mortgages were approved in the UK in 2012, with 932,000 housing transactions. However the net impact is likely to be less than 190,000 because at least some purchases would have gone ahead without the scheme (e.g. raising a larger deposit with help from parents).
The Treasury will have to resolve several key design issues. The size of the commercial fee lenders will have to pay to Treasury to ensure the scheme is self funding could, if large, have a significant impact on the affordability of the scheme for home buyers. Will Treasury set it in line with commercial mortgage indemnity guarantee (MIG) fees, currently around 2%, to avoid creating unfair competition with the private sector? How will lenders recoup the fee from borrowers: an upfront fee (difficult for a buyer with only a 5% deposit); by loading it onto the mortgage (thereby raising it to a 97% LTV); by charging a higher mortgage rate?
Also, how much capital relief will the FCA allow lenders, given that the guarantee only covers 95% of any loss down to 80%? And given the fee and capital relief, what interest rates will the lenders charge? Experience with NewBuy suggests they won’t play their hands until the scheme goes live in January.
The design of the final stages of the scheme will be critically important. To avoid causing market disruption, the Mortgage Guarantee scheme will have to taper off during 2016 rather than drop off a cliff edge in December. Unfortunately withdrawal may coincide with a very sensitive time for the housing market. The financial markets currently expect interest rates to start rising during 2015. The Funding for Lending Scheme, which has significantly reduced mortgage rates, is currently scheduled to end in January 2015, potentially adding to upward pressure on rates. From today’s perspective, we cannot know whether lenders will be prepared to offer 95% LTV mortgages beyond 2016, possibly supported by commercial MIG policies, or whether withdrawal of HtB will leave a gaping hole in the market. And will the broader economic environment be positive for the housing market in 2016?
Price and volume responses
There has been widespread criticism of HtB, most of which seems to relate to the Mortgage Guarantee scheme. A major concern is that it will boost demand without any compensating increase in supply so that the Chancellor will merely create a house price bubble, making housing even less affordable for the very people he is trying to help. Academics argue that UK housing supply is extremely inelastic, with a near vertical supply curve, so supply cannot respond. Therefore any boost to demand largely feeds into higher prices.
As already noted, the Equity Loan scheme’s net impact on new home demand will be substantially lower than gross sales under the scheme. My own view is that new supply will increase to support this net extra demand, with minimal longer-term impact on new home prices. I regard the reformed English planning system under the National Planning Policy Framework (NPPF) as our best chance for 20 years to improve supply responsiveness, but only time will tell. The industry is operating at historically low levels of output, there is spare capacity within home building companies (though perhaps less so for site trades) and the larger companies have gone a long way towards rebuilding their balance sheets and profit margins. Valuers will also play an important role in holding back any tendency for new home prices to rise, especially as the HCA’s rules require the house builder’s selling price to equal the first-charge lender’s valuation. Early supply indicators are very positive.
The price and volume impacts of the Mortgage Guarantee scheme are more difficult to assess. Having geared up production in response to the Equity Loan scheme, home builders may have limited capacity for a further increase in response to the Guarantee scheme. However a proportion of buyers taking advantage of the scheme will also be sellers, thus creating additional second-hand supply. From our experience with NewBuy, this could be perhaps a third of buyers. And as already noted, some buyers would have bought anyway. Therefore the net increase in demand, after allowing for the increase in second-hand supply, will be less, and possibly substantially less, than the 190,000 gross sales the Treasury is assuming.
And if house prices do begin to surge, the Treasury and the Financial and Monetary Policy Committees may seek to intervene to reduce the scheme’s impact, though perhaps not till after the May 2015 General Election.
Note: This article gives the views of the author, and not the position of the British Politics and Policy blog, nor of the London School of Economics. Please read our comments policy before posting.
John Stewart is Director of Economic Affairs at the Home Builders Federation (HBF). He has a wide range of policy responsibilities, including the economy, the housing and mortgage markets, housing supply, the private rented sector, valuation, NewBuy, HCA initiatives (Help to Buy: Equity Loan, Affordable Housing, Get Britain Building, public land disposal), the new home Customer Satisfaction Survey and industry Code of Conduct. Before joining HBF in 2003 he was an independent housing consultant and previously divisional Sales & Marketing Director for house builder Wates. He has an MA in English from Auckland University and an MSc in Economics from Birkbeck College, London.
