Money News Feature

Equity loans and key worker mortgages

Updated Monday 11 July, 2011

By Martin Fagan news@consumerchoices.co.uk

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Many who struggle to get on the housing ladder may qualify for an equity loan. But what are they? How do they work? How much do they cost? How do you get one?.

Even though house prices have fallen since 2008 and the Bank of England’s base rate has been at an historic low of 0.5% for over two years now, getting on the housing ladder for first-time buyers and key workers such as teachers, fire fighters and armed forces personnel, is still a struggle.

One problem is that salaries have failed to rise at the same rate as house prices, meaning the standard measure of affordability – generally three times gross (before tax) salary – is meaningless when the average annual UK salary is £25,948 (source: Office of National Statistics) but the average UK house price is £161,823 (source: Land Registry), or just over six times the average salary.

If you’re a first-time buyer who can’t afford to buy a home, you may be able to get help through an ‘equity loan’ scheme.

What is an equity loan and how does it work?

Equity loans are available on certain new-build homes on specific housing developments across England. With an equity loan, you buy a minimum share of 70% in the property in a conventional way with the cost met by a regular mortgage. The remaining cost of the home (30% maximum) is met by the government and the housebuilder through an equity loan.

For example, if you buy £100,000 property, your mortgage will cover £70,000 (70%) of the price and the equity loan is £30,000 (the remaining 30%). If you sold the property three years later for £130,000, then you would have to pay back 30%, or £39,000.

It is called an equity loan because its value changes based on how much your home is worth. This means the amount you owe will rise and fall with the value of your home. The property’s title deeds will be in your name, which means you can sell your home at any time. However, when you sell, the government and the housebuilder will then get the same 30% share of your home at the price you sell it for.

For example, if you buy a £100,000 property, your mortgage will cover £70,000 (70%) of the price and the equity loan will cover £30,000 (the remaining 30%). If you sold the property three years later for £130,000, then you would have to pay back 30%, or £39,000.

If you remain in the property, the equity loan is only free for the first five years. In the sixth year, you’ll be charged a fee of 1.75% of the loan, with the loan’s value determined by how much the price of the property has changed over those five years. Every year after this, the fee will increase. The amount it increases by is worked out by using the Retail Price Index (RPI) plus 1%.

So if after five years the price of your property has increased to £130,000 and the equity loan is £39,000, you’ll pay an annual fee of 1.75% of this, which is £682.50, or £58.88 a month. And remember: this fee is in addition to your mortgage payments and doesn’t count towards paying back the equity loan.

The following year and each year thereafter, the RPI factor kicks in. This means that if the RPI was 5% that year, the 1.75 per cent fee would increase by 6% (RPI plus 1%) to 1.86% which, if the equity loan was still £39,000, the annual fee would be £725.40. If RPI continues to rise over the years, so will the annual fee and it will increase further if property prices rise. This is how the equity loan provider earns a return on the money it lends you.

If you pay back all or part of the equity loan early, you will pay less in fees and get to keep more of the money when you sell your home. This is known as “staircasing”. If you pay back the whole equity loan within five years, you won't pay any fees. However, if you’re happy and content in your home and stay there for 25 years, not only will you pay the annual fee for 20 years, after 25 years, even if you don’t want to move, you’ll still have to pay back the equity loan. So if the property originally cost you £100,000 and it increases in value by a conservative 3% per year for 25 years, it’ll be worth £209,000 and the equity loan will be £62,700.

So the key with an equity loan is to pay it down as soon as you can afford to. The sooner you pay it off, the fewer annual fees you’ll pay and the sooner you’ll own 100% of the property and its concomitant price increases.

Who qualifies for an equity loan?

You can only buy a home through an equity loan scheme if:

your household earns £60,000 a year or less
you can’t otherwise afford to buy a home in your area
A household is the number of people who are buying the home. For example, a household might be you alone or you and your partner

Equity loans are open to:

people who rent council or housing association properties
first-time buyers
You can also get help through an equity loan even if you previously owned your home, but can't afford to buy one now

In practice, different regions have different priority groups they favour and interpret the rules of who qualifies and their eligibility in their own way. What makes you a perfect candidate for an equity loan in the North East of England won’t necessarily means you’ll be eligible for one in the West Midlands.

Also, people referred to as key workers (nurses, police, teachers, etc.) have been targeted as those most in need of assistance and, where possible, are sent straight to the head of the queue.

Who counts as an eligible key worker?

Those considered to be key workers include:

NHS staff (except doctors and dentists)
Teachers
Police officers, and community support officers
Prison officers
Probation service employees
Planners working in a local authority
Fire fighters
Connexions personal advisers
Armed Forces personnel
Qualified environmental health officers
Highways Agency staff
Social workers, educational psychologists and therapists employed by local authorities.

For a full list, have a look at the HomeBuy agent website.

So what’s the catch?

As the money for equity loans comes principally from the government of the day, and because succeeding governments have a scorched earth policy to the accomplishments of their predecessors, the first catch with equity loans is the utter confusion over which government agency actually provides the cash.

The hangover from the last government is HomeBuy Direct, but this agency’s future is in doubt after the Coalition’s first Budget in March 2011, where George Osborne announced the formation of the FirstBuy scheme.

HomeBuy is a network of agents and housing associations throughout the country who work in partnership with house builders such as Taylor Wimpey, Persimmon and Barrett. The deals are location-specific (wherever a developer is building an estate) and are for new-builds only.

If you’re in any doubt whether or not you’re eligible for an equity loan – or if your circumstances or occupation qualify you as a priority case – your first port of call will be your local HomeBuy agent.

What’s the difference between HomeBuy and FirstBuy?

Where HomeBuy is an equity loan scheme (the principles of which are outlined above), FirstBuy has been outlined as a shared equity arrangement where the Government and the property developer provide a loan (interest free for five years) to cover a proportion of the value of the property.

Under the FirstBuy scheme this proportion is 20% of the purchase price. The buyer will be expected to contribute a minimum cash deposit of 5% themselves as well as secure a mortgage for the other 75% of the purchase price.

Details about the further existence or feasibility of HomeBuy are thin on the ground. No one –the government or HomeBuy itself – seems to have made any announcements about the agency’s future. Nor has the government disclosed much information about FirstBuy, other than the barest bones of what it will do. It’s unclear whether after five years a FirstBuy loan will attract interest or an annual inflation-linked fee, like an equity loan.

Shared ownership schemes run by house builders

If the complexity and layers of government bureaucracy are too much to wade through, you could just go direct to a house building company who may be running an equity loan scheme with local housing associations completely independent of government.

In a housing slump, an equity loan scheme is a way for a house building company to sell its empty properties at a discount to cover its immediate costs with the likelihood of recouping the company’s profit – the equity loan - at a later date.

So far, government funding for shared-equity schemes has lagged behind that provided by the private sector. The Labour Government pledged £450million for its HomeBuy scheme while the current Government has said it will make £250million available for FirstBuy.