Is the Help to Buy scheme leaving young homeowners in “indentured servitude”?

A prominent City economist used this phrase last week to describe the impacts of Help to Buy, the government’s flagship housing policy. David Kingman asks whether this is a fair assessment.House Prices

We all know that young people have an incredibly difficult time getting onto the housing ladder in Britain today. This has only got worse since the beginning of the recession as the banks have become far more cautious about lending large sums to would-be homeowners in their 20s and 30s – leading to a large increase in the size of the cash deposits that they are being asked to produce up-front in order to qualify for a mortgage.

In order to address some of the challenges facing first-time buyers, Chancellor George Osborne announced in his budget back in March that he was launching a new scheme called “Help to Buy”, under which the government would assume some of the lenders’ risk to make them more willing to finance mortgages for younger borrowers.

However, his plan has proved controversial, and this week it was the subject of sharp criticism from a leading City economist. Is Help to Buy the right policy to pursue? And does it actually help young first time buyers?

How does Help to Buy work?

The Help to Buy scheme has two parts, one of which consists of the government providing 20% equity loans to help people purchase houses, and the other of which involves them guaranteeing mortgages. The former scheme began almost as soon as it was announced in the 2013 budget, whereas the latter doesn’t come into action until January 2014. As the details of how the mortgage guarantee scheme will work have not yet been fully released, the rest of this article will deal exclusively with the part of the scheme which provides equity loans.

As explained on the scheme’s website, Help to Buy equity loans are available to meet up to 20% of the purchase price of a new-build home with a value of up to £600,000.

Under the structure of a Help to Buy deal, the cost of purchasing a home is broken down into three components: a deposit worth 5% of the property’s value, a mortgage worth 75% and a Help to Buy loan which covers the remaining 20%. The point of this structure is that, if the government wasn’t getting involved, the bank lending the mortgage would be very worried about whether or not the buyer was going to default on the loan, so they would want them to pay much more of the cost up-front in the form of a deposit.

First time buyers are typically young workers who tend to be short of money or accumulated assets, so having to raise a substantial deposit has become a major obstacle preventing them from getting onto the housing ladder. The typical deposit for a first-time buyer has spent a prolonged period hovering at around 20% of the typical purchase price, which amounts to around 80% of the average first-time buyer’s income. Given that it would be a commendable achievement if the typical person at this stage in their life managed to save 10% or even 5% of their income to fund a deposit, it should not come as a surprise that the average age of the average first-time buyer who doesn’t receive help in paying for their deposit has been rising.

Therefore, the impact of the equity stake provided by the government should be to decrease the lender’s exposure to losses, with the result that they can afford to ask for a significantly lower deposit. This, in turn, should make it easier for first-time buyers to gain access to mortgages.

Of course, the downside to this scheme is that the taxpayer is exposed to losses on the money which has been lent out. When the home is sold the government gets its equity stake returned to it, plus or minus any losses or gains. For example, if the government originally leant £20,000 to someone purchasing a home for £100,000 and it was sold two years later for £110,000, the government would be repaid £22,000. If the home went down in value, or was foreclosed, then the taxpayer would be liable for 20% of the losses.

Do young people need Help to Buy?

The scheme is supposed to run for three years. It has mainly been criticised on two grounds: firstly, that it is economically flawed, and secondly, that it pursues the wrong housing policy objective.

Critics arguing that Help to Buy is economically flawed would emphasize that the government is effectively trying to second-guess the experts within the housing industry – and committing a large sum of public money (possibly guaranteeing up to £130 billion worth of mortgages) to do so.

The mortgage lenders have been denying younger borrowers access to mortgages and demanding higher deposits for a reason; they predict that heavily-indebted first-time buyers are likely to default and end up not paying the money back. The government is effectively saying that this concern is misplaced, and it is happy to back up this view with its own money, which looks like a risky gamble to take during the age of austerity.

In terms of housing policy, this is where the criticism levelled at Help to Buy by the leading City economist Albert Edwards, head of the global strategy team at Société Générale, comes in. He argued that the scheme will put young borrowers into “indentured servitude” trying to pay off large mortgages, because the scheme does nothing to reduce house prices. Indeed, it is likely to have the opposite effect of propping them up, when you would expect housing to become substantially cheaper following a recession.

Several other groups, including Shelter and the housing campaign group Priced Out, echoed this criticism of the Help to Buy scheme, while arguing that the public funds could have been better spent on policies that aimed to increase housing supply, which would have had the result of making housing more affordable anyway.

Is this policy, then, a sop to the older generations who own most of Britain’s property, many of whom are relying on housing equity to act as their pension? Possibly. In any case, whilst it is good that the politicians have the plight of young first-time buyers at heart, simply allowing them to be burdened with more and more debts backed up by taxpayers’ money certainly seems a rather questionable policy for the government to pursue.

Posted on: 17 June, 2013

2 thoughts on “Is the Help to Buy scheme leaving young homeowners in “indentured servitude”?

  1. Andrew

    First of all, let’s forget any notion that the Government cares about the housing needs of young people. The Government’s objective remains the same as it has been since the mid 1990s, to at least sustain and preferably increase house prices. It is too well established that recent initiatives to ‘help’ first time buyers have had an opposite, hyperinflationary effect and the suggestion that economists at the Treasury don’t already understand this is not credible.

    Second of all, the scheme is not only open to first time buyers but also those who want to move up the property ladder. In a healthy property market that is behaving normally, we have to ask why this would be necessary?

    Behind the smokescreen, the Government’s intention is to safeguard those nearing retirement who plan to live on the equity of their homes. It doesn’t take a genius to spot that Britain’s housing market has been mutated, like most government meddling, without any kind of succession plan in mind. Very few people in the South East of England buy at all before their mid-thirties and that age is rising; by the time they’re able to afford the bigger homes, they’ll be ready to downsize!

    On the flip side, an awful lot of the bigger houses in the South East of England are underoccupied. Instinct tells me that an awful lot of people might want to downsize soon to realise the equity on their homes in retirement. The result in a free market would be a collapse of values at the higher end of the market; clearly this is why Help to Buy is not just open to first time buyers. The Government’s intention here is to meddle with the market some more to create a workable succession plan in an overvalued market.

    Hyperinflation in property values would be far more palatable if they were credible. Whilst I accept people are willing to take absurd risks that might suggest the demand is there, this demand is only possible with intervention from government and large financial institutions. Those buying are also grossly misinformed and naively believe property ownership at today’s prices will give them a lifestyle similar to their parents in the future. It would be very helpful to release statistics showing how much of a person’s income will be spent on a house buying today compared to 30 years ago. Factoring in low inflation and lower real wages I imagine the results would be not only staggering but politically motivating to young people.

    They might even bring about an end to using taxpayer money to fuel property inflation. Government has run at very low interest rates for about 5 years destroying the value of the pound to prevent defaults; they continue to support part ownership, which means people now throw everything they’ve got at half a house instead of a whole one; they give tax breaks on mortgage interest on second homes (our money is actually used to cover tax breaks for buy to letters, which is frankly disgusting) and now they want to cause 20% inflation in the market with their loan schemes.

    Finally, if houses are actually worth, on average, £240k, then surely there must be enough demand currently to sustain this value? Surely this means throwing billions at the market will just cause more inflation as first time buyers are given extra cash to compete with the existing market. Yet, it’s well established that houses aren’t selling all that fast. The real value sustainer is people unable to sell for less.

    So maybe if governments need to lend people 20% of the value to buy them, then this implies that the government needs to lend people money to sustain the existing market value. I’d rather see a free market crash than have to take a loan from UK plc.

  2. Jan Brown

    Re ‘Indentured servitude’ – isn’t that what I and millions of others of 60+ had to do for 40 or 50 or more years? Go to work to find the money to pay the bills so we can live to go to work another day?

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