First-time buyers should be wary of new mortgage schemes
The latest methods to get people into the housing market will be suitable for some buyers but there are a few pitfalls. Chiara Cavaglieri reports
Sunday 26 June 2011
It has been a red-letter week for the UK property market, with the Government's FirstBuy initiative opening up to first-time buyers (FTBs) and the announcement that mortgage and investment firm Castle Trust will launch its partnership mortgages later this year.
While innovative new products that aim to breathe life into the housing market should be encouraged, experts warn that homebuyers should not follow blindly.
Under FirstBuy, the Government and housebuilders such as Persimmon, Bovis Homes and Barratt Developments will join forces to offer new homeowners a loan of up to 20 per cent of the property price, so that they need only a 5 per cent deposit to qualify for a 75 per cent mortgage. Several lenders including Barclays, Halifax and Nationwide have already agreed to offer FirstBuy mortgages. However, this scheme is expected to help only about 10,000 people.
For other buyers needing a help, new lender Castle Trust is promising to unlock the housing market by offering to share the cost of their deposit. In return, when it's time to sell the property or the mortgage comes to an end, the firm will take its share of any rise in the value.
"It's really aimed at families that would like someone to share the costs and risks of buying a home. Typically they would have owned a home before and would like someone to fund that extra bedroom for a number of years," says Sean Oldfield, the chief executive officer of Castle Trust.
The mortgage business will be funded by deposits taken from outside retail investors buying into Castle Trust's investment arm. The firm is offering various fixed-term investments linked to the Halifax price index with returns based on sharing profits on properties they have helped to purchase, or indeed to bear the losses if there is a property crash.
As a borrower, you must be under 55, have a good credit history and be able to put up a minimum 20 per cent deposit, which Castle Trust then matches enabling you to apply for a 60 per cent LTV mortgage from another lender. There are no monthly repayments owed to the firm and, unlike the FirstBuy loan, which is interest free for five years with interest charged at 1.75 per cent in year six and at inflation plus 1 per cent thereafter, there is no interest to pay. Instead, when it's time to sell, the firm will either take a large chunk of any increase in the property's value, or if the price has fallen, Castle Trust will take its money back but, uniquely, it will shoulder a percentage of any losses.
"If you sell your home for less than you paid for it, you will repay us the 20 per cent we loaned less 20 per cent of any loss, so we share in the losses and you'll repay less than you borrowed. But, if your house price rises we'll share in 40 per cent of the growth," says Mr Oldfield.
The other big pull with a partnership mortgage is that you could potentially access much better deals when financing the rest of the purchase.
As an example, on a traditional repayment mortgage for a property worth £200,000, if you had a 25 per cent deposit of £50,000, the remaining 75 per cent would have to be funded by a mortgage of £150,000. Based on the average two-year fixed rate from the five largest mortgage lenders at the beginning of May this year, you could secure an interest rate of 3.96 per cent and your monthly repayments would be £789. If you had Castle Trust on board helping you with another £40,000 (20 per cent) you would need only a £110,000 mortgage and could potentially secure a much sharper interest rate of 3.67 per cent instead, meaning that your monthly repayments would fall to £561.
While savings of this nature should not be dismissed, with the company taking a good chunk of potential profits, homebuyers must go into this with their eyes wide open. First of all, Castle Trust isn't open for business yet and is still awaiting authorisation from the Financial Services Authority (FSA). If and when it gets this, however, there are still significant issues.
We are yet to see whether mainstream lenders will get on board with the idea and there have already been reports that several of the major lenders would not lend to borrowers taking out a partnership mortgage.
"One of the unknowns will be how lenders greet the product. The idea is that you get access to the better rates on offer because you are borrowing at 60 per cent rather than 80, but we'll have to see if that's how things pan out. Lenders could instead offer a special range which may not be as sharply priced as the core range. That is certainly how shared equity has worked ion the past," says David Hollingworth of independent mortgage broker London & Country.
There could also be problems at the end of the mortgage term: if you have no other savings or investments to repay your mortgage, you may be forced to sell your home. And, if you default on any payments on your main mortgage for more than 60 days, Castle Trust will demand its loan back.
You could also find that while a partnership mortgage is helpful now, when you buy your next home, you could struggle even more to get a decent deposit together because any increase in the value of your home will immediately succumb to that 40 per cent payout to Castle Trust.
"Deciding on whether or not it represents a good deal will depend on your circumstances and the impact it has on your cost of borrowing," says Martin Bamford of independent financial adviser Informed Choice.
In theory, you will be able to make significant savings on your interest payments. However, even if you can then sell the property at a considerable profit, you may not be left with enough to finance a new purchase.
"This needs to be compared to the money you effectively 'lose' when you sell the property. If the property increased in value by 25 per cent over 10 years to £250,000, you would be repaying the £40,000 Castle originally invested plus £20,000 of the £50,000 growth," says Mr Bamford.
Things get complicated if you want to pay off some or all of your mortgage early without selling your home, or if you sell within 12 months. Castle Trust will not share losses if the price falls, and you must repay the loan plus an additional repayment of 4.5 per cent a year, or 40 per cent of any increase in the value, whichever is greater.
David Hollingworth, London & Country
"Borrowers should not consider the partnership mortgage as a cheap option and lender attitude to the shared equity element will be very important to its level of appeal. You also need to be fully aware that the lender is out to make money so are betting that their investment, which is in effect part ownership of your house, will actually increase in value more than they pay for it. This mortgage certainly won't be for everyone."
Independent Partners: Get fee-free expert mortgage advice and find the right mortgage deal for you.
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