“Help to Buy”: promoting unsustainable debt

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The coalition government has brought forward ‘Help to Buy’ in an attempt to boost housing market activity. It provides, by way of the Homes and Communities Agency, an ‘equity loan’ to people who want to buy a house but cannot raise the large deposits that have been required since the housing crash. These may be up to 25% of the cost of the house for a first time buyer. ‘Help to Buy’ requires a minimum 5% deposit and the government will provide up to 20% ‘equity loan’ to bridge the gap between what the buyer can raise and what the deposit would otherwise be. The scheme provides £3.5 billion for an estimated 74,000 buyers. However, ‘Help to Buy’ is not just directed at first time buyers. It is designed to encourage any activity in the housing market. It applies to houses up to £600,000. So somebody sufficiently well off to buy a £600,000 house can get a loan of £120,000 from the government. Contrast this with the treatment of people on benefit, some of whom are expected to live on £71 a week Job Seekers Allowance and now face a benefit cut as a result of the ‘bedroom tax’.

With ‘Help to Buy’, if you took out a mortgage for a £200,000 house, you would owe £150,000 to the building society or bank, have to find a £10,000 deposit and would borrow an ‘equity loan’ from the government of £40,000. A £100,000 house would require a £5,000 deposit, a mortgage of £75,000 and an equity loan of £20,000.

A nice little earner for the government

Whilst this may bridge the gap between the deposit that somebody can raise and what would usually be demanded by the lender, it simply cuts the cost of up-front payments. You will still have to pay up to 25% of the cost of the house, the only difference being that you will have to pay 20% when you sell the house or at the end of the mortgage term. In addition, unlike an ordinary mortgage through which you borrow a definite amount, if the price of the house rises from when you buy it to when you sell it, or at the end of the mortgage period, you will have to pay back the government 20% of the value of the house, whatever it is. So if the house increases in value from £100,000 to £150,000, then instead of owing the government £20,000 you will have to pay them £30,000! A nice little earner as someone once said. A £200,000 house increasing by a similar amount will mean that you have to pay the government £60,000 instead of £40,000. Let’s hope people have read the small print.

One of the attractions of ‘Help to Buy’ is that for the first 5 years the ‘equity loan’ is interest free, though like the infamous ‘sub-prime mortgages’ this has a sting in the tail. After five years there is an annual fee of 1.75%, increasing by RPI plus 1%. This is in addition to the mortgage and the equity loan. Curiously, whilst there has been much in the media about the potential danger of this scheme to the economy promoting a housing bubble, with a crash at its end, there has been little about the risks to the borrowers themselves.

The scheme cuts the monthly payments as compared to an ordinary mortgage but it simply delays the evil day, when the ‘equity loan’ will have to be paid, and if, after five years the borrower is struggling financially, they will face the added expense of the annual fee, subject to inflation, with the government choosing the usually higher RPI as opposed to CPI. This may push the borrower over the edge.

An “Englishman’s home is his castle” we are often told. However, in this case you can’t extend or alter the property without the agreement of the loan company – “consent will not usually be granted for significant home improvements”.

‘Help to Buy’ is already in place and has caused an increase in activity. Eric Pickles has announced the success of the scheme and declared that ‘Britain is building again’, as if it had stopped altogether. There have been 10,000 ‘reservations’ since April of this year. However, that does not mean that they will get the mortgage they want. We will see what the results are later.

Guarantee to the lender

The second part of the scheme, the guarantees to the lenders, worth a whopping £12 billion, starts in January 2014. It’s supposed to run for 3 years, and is estimated to provide support for up to 300,000 mortgages. Under this “the government will compensate the lender for a portion of the net losses suffered in the event of repossession”. The lender will be able to buy a guarantee worth up to 15% of the loan for a fee for each mortgage. The government says that the fee will be set at a level which will mean the scheme is ‘self-financing’. However, the price of the fee has still to be announced. The Treasury says it will offer bands of prices based on the loan to value of the mortgage, with higher LTVs likely to cost the most as they are riskier. However, this poses a question mark over whether many loans to first time buyers with deposits at 5% will be forthcoming.

“Lenders say they need to see changes to the rules on the amount of capital they are required to hold to back 95% mortgages for the loans taken under the scheme, otherwise they will not be able to offer cheap mortgages at that level.”

The House of Commons Treasury Committee believes that the government will find it very difficult to set the fee at such a level as to minimise the risk to the tax payer. It expressed concerned that

“The mortgage guarantee scheme now makes the government an active player in the mortgage market. The committee is concerned that the Treasury now has a financial  interest in maintaining house prices to limit losses to the tax payer.”

If the fee is set too high then lenders will not offer loans, especially those with a 5% deposit. If it is set too low then the liability to the tax payer will increase.

“Leverage themselves up to the hilt”

Widespread concern has been expressed at the danger of ‘Help to Buy’ fuelling house prices without significantly increasing house building. They are rising now at the fastest rate since the 2006 peak according to the Royal Institute of Chartered Accountants. Even members of the government, Vince Cable, for example have expressed concern that ‘Help to Buy’ might trigger a house price bubble.

According to the government’s estimate there are 240,000 new households formed each year. Yet the number of homes built was only 107,820 in 2012-13 in England (Department of Communities and Local Government live tables). The decline in mortgages pre-dated the crash, largely as a result of the steep increase in prices, putting them beyond the reach of many people. The credit crunch exacerbated this trend. Between 2003-4 and 2009-10 the number of people buying a house with a mortgage (in England) declined from 8,521,000 to 7,695,000 (DCLG).

Before the crash the ratio of (the cheapest) lower quartile house prices to lower quartile earnings was 7.25 (DCLG). Whilst the housing crash and the recession saw a decline in this level, by 2012 the average price was still estimated at 6.59 times income. Moreover, this is not just a problem for those on low wages. A comparison of median house price to median wages indicated a ratio of 6.74 times income in 2012.

In relation to ‘Help to Buy’, the Financial Times commentator Martin Wolf hit the nail on the head when he said

“This is good politics and horrendous economics. Since the peak of the boom, UK house prices have fallen by only 16 per cent in real terms, against some 40 per cent in the US. The ratio of median earnings to median house prices has fallen only 7 per cent from its peak. The government is encouraging people to leverage themselves up to the hilt in order to buy what is already likely to be overpriced property and, as a result of this policy, is likely to become still more so (my emphasis). This is irresponsible enough. But worse, the government will probably now find itself permanently using its balance sheet to support risky housing finance, as the US has done. The market cannot sensibly finance such high loan-to-value ratios. But this fundamental lesson from the crisis is now being thrown away.”

It’s ironic that a government which says that an unprecedented scale of public spending cuts is necessary to get public debt quickly, is prepared to promote probably unsustainable private debt to ‘kick-start’ the housing market.

The Chief Economist of the Institute of Directors said:

“The housing market needs help to supply, not help to buy and the extension of the scheme is very dangerous…the world must have gone mad for us now to be discussing endless tax-payer guarantees for mortgages.”

Analyst Albert Edwards, of Society Generale, described it as a ‘moronic policy’.

“Why are houses too expensive in the UK? Too much debt. So what is George Osborne’s solution for first time buyers unable to afford housing? Why, arrange for a government-guaranteed scheme to burden young people with even more debt!”

He described this as “indentured servitude of our young people”.

‘Priced Out – the campaign for affordable house prices’ sums up Help to Buy well.

“Help to Buy should really be called ‘Help to Sell’, as the main winners will be developers and existing home owners who will find it easier to sell at inflated prices. Pumping more money into a housing market with chronic under-supply has one sure-fire outcome: pushing up house prices. At best it may help a small number of new buyers, but it will mean housing become more expensive for all those that follow.”

The rise in home ownership

The historic rise in home ownership to 70.9% in 2003 was the product not of the ‘free market’ but of government policy which facilitated people who could not afford to buy a house on the open market to do so. Thatcher’s ‘Right to Buy’ was the biggest stimulus based on a subsidy of home ownership, giving away Council homes on the cheap. House ownership was also promoted by what, after the crash, Gordon Brown described as ‘irresponsible lending’ including self-certification with no check on the mortgagee’s income. At the height of the boom 100% mortgages were common and courtesy of Northern Rock we even saw the 125% mortgage. Yet home ownership has declined from 2003 as a result of house price inflation way beyond the increase in the level of earnings. Today ownership has declined to just under 65%.

Attempts to stimulate growth in home ownership today ignore the fact that a decline was inevitable so long as prices remain way above what people can realistically afford. Whilst sections of the mass media applaud the current rise in house prices, this will put home ownership beyond the means of even more people. Likewise the big increase in ‘buy to let’ mortgages is freezing out first time buyers from homes that they would be interested in. The Council of Mortgage Lenders data showed 40,000 ‘buy to let’ loans advanced in the second quarter of 2013, the highest level in four and a half years, accounting for over 13% of outstanding lending in the UK. By the end of June there were 1.48 million buy to let mortgages outstanding. Half of the lending is re-mortgages by existing landlords keen to increase their stock. They are keen to take advantage of the demand for rented accommodation resulting from the failure of the government to support ‘social housing’.

The ‘flexible labour market’, insecure employment, and a decline in the value of wages mean that less people can afford a mortgage and less are prepared to take the risk. Hence the big increase in the numbers of private rent homes that have just crept ahead of the ‘social housing’ numbers. (See this is Swindon: https://martinwicks.wordpress.com/2013/02/14/swindons-census-what-does-it-tell-us-about-the-housing-crisis-in-swindon )

Despite the worship of home ownership the fact remains that a large proportion of the population does not earn enough to gain a mortgage. In the financial year 2012-13, 45% of the tax-paying population had an income of less than £20,000 a year, with 69% earning less than £30,000 (Office of National Statistics). The financial pressure that people are under is reflected in the ONS’s “measuring national well-being – Households and families, 2012”. It’s estimate on family savings is instructive. The average for all the population shows 30% with no savings whatsoever, and 19% with less than £1,500 savings. As you would expect the percentage of those with no savings who are on very low incomes is higher; 46% of those with an income of less than £200 a week have no savings and a further 17% have less than £1,500. What is perhaps surprising is that of those with over £500 (but less than £600 a week) 30% have no savings, and of those even with £1,000 or more a week, 12% have no savings and 15% less than £1,500. This indicates that a considerable section of the populace is in a precarious situation despite higher than average income. Of course, prior to the crash lenders were encouraging people to take on more and more debt without any consideration of the consequences.

The Economist recently commented that rising household debt is sustainable “only if workers’ future wages justify the mortgages granted against them”. Yet there is no prospect of this in an economy in which wage rises are well behind inflation and there is a growing casualisation of work, reflected in the recent news that there are probably more than a million workers on zero hours contracts. There is still no sign of unemployment falling below 2.5 million and the number of workers in part-time work only because they cannot find full-time work has risen above 1.4 million.

Cynical ploy

‘Help to Buy’ is part of the government’s strategy to try and increase economic activity so that they can plausibly present a picture of success in getting the economy on its feet again. ‘It’s on the mend’, says Osborne. Yet this policy will simply encourage people to take on what is likely to prove to be unsustainable levels of personal debt. In order to do so the government is underwriting lenders to provide mortgages to people whom they would not otherwise lend to. ‘Help to Buy’ is a cynical ploy aimed at increasing housing market activity, with one eye on the next General Election. It is designed to get the government re-elected not to tackle the housing crisis.

The government’s dogmatic opposition to Council housing prevents them from addressing the need for genuinely affordable homes for rent for those who cannot afford a mortgage. Perhaps one of the reasons why this government, and its predecessor, refused to accept the need for a mass council house building programme, was the likelihood that it would drag house values down. Yet a decline in house values is not a disaster for most people, the majority of whom view their house as a place to live rather than an investment. Even if the value rises, most people cannot realise the value, because they still need to live somewhere, and the value of alternatives has risen as well. So long as house prices continue to rise then home ownership will continue to decline. All the signs are that ‘Help to Buy’ will promote house price inflation at a time when earnings are stagnating and their value falling.

Martin Wicks

August 16th 2013


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