Help to Buy Equity Loans
What they are & how to pay them off
Help to Buy equity loans are an increasingly popular means of getting on to the housing ladder in England, with more than 236,000 properties purchased using the scheme since 2013. For some, it's the only way, but equity loans add another layer of complexity to the home-buying process. It's important to know exactly how they work, and their potential additional cost.
This guide focuses on the Help to Buy Equity Loan scheme in England. There are similar schemes available in Scotland and Wales – for more on these, see below.
Update: 31 July 2020. Help to Buy Equity Loans deadline extended by two months
The Government has extended the Help to Buy Equity Loans deadline for when new homes have to be physically constructed from the end of December to end of February 2021 to offset any delays due to the coronavirus pandemic.
However, the completion of sale will remain 31 March 2021, apart from where proceedings have been severely delayed by coronavirus - in that case, the completion of sale deadline will be pushed back to 31 May 2021 (this is restricted to those who had a reservation in place by 30 June 2020).
Once the deadline's up the current Help to Buy Equity Loan scheme will become restricted to first-time buyers, and it will end completely in 2023.
Help to Buy equity loan: the basics
Launched in 2013, the Help to Buy Equity Loan scheme is designed to help those who are struggling to save for a deposit for a home to get on to the housing ladder.
An equity loan, worth up to 20% of a property's value (or up to 40% in London), is used by a potential buyer to 'fatten up' their deposit. A bigger deposit gives you access to better mortgage rates, and you also don't have to worry about paying interest on the equity loan for the first five years.
Plus, you don't have to repay the equity loan itself until you come to sell your property, OR at the end of your mortgage term (max 25 years) – whichever of these comes sooner. Here are a few quick need-to-knows...
First-time buyers and previous homeowners can apply
Under the current format, both first-time buyers or previous homeowners who no longer own a property can apply.
This is set to change in April 2021 though, when the scheme will only be available to first-time buyers. The scheme is set to end completely on 31 March 2023.
You'll need to be buying a NEW-BUILD home
Help to Buy equity loans can only be used to purchase new-build homes. In other words, you can't use the equity loan to purchase a home that's already been lived in.
The property you're buying can be worth up to £600,000, but no more.
To find which homes in your area can be purchased using an equity loan, you can browse your local Help to Buy agent website. Currently there is an Agent for the North, an Agent for the Midlands and London and an Agent for the South. On these websites you simply type in the area you're looking to buy, and you can see which properties can be bought in that area using the equity loan scheme. It'll also list which building developers are involved in the scheme.
A minimum deposit of 5% is required
You'll need to have at least a 5% deposit to be eligible for an equity loan.
An equity loan worth up to 20% of the property's value can then be taken out. In effect, the equity loan 'tops up' your deposit – the aim being to give you access to cheaper mortgage rates.
In short, this is how the numbers work:
- You put up at least a 5% deposit.
- You borrow up to 20% of the value of the property you intend to buy (this is the equity loan).
- You apply for a mortgage to cover the remaining cost.
Here's an example.
Let's say you want to buy a new-build home worth £200,000... Using the equity loan scheme you could put down a 5% deposit (£10,000) and take out an equity loan worth 20% (£40,000), so you'd only need to apply for a 75% mortgage (£150,000).
The equity loan rules only state that you must provide at least a 5% cash deposit, and take out a mortgage for at least 25% of the value of the property.
So in theory, you could put down a 30% deposit, get a 20% equity loan and take out a 50% mortgage. On a £200,000 property, a 30% deposit equals £60,000, a 20% equity loan equals £40,000, and a 50% mortgage equals £100,000.
An equity loan can be worth up £120,000 (or up to £240,000 in London)
As explained above, an equity loan can be used to buy a property worth up to £600,000.
The loan itself can be worth up to 20% of the property's value (or 40% if you're buying in London). So outside of London you can borrow up to £120,000, while in London you could use an equity loan to borrow up to £240,000.
Remember. Whatever you borrow with an equity loan is separate to your actual mortgage. In effect, you will be taking out TWO separate loan agreements.
Equity loans are INTEREST-FREE for the first five years
One of the biggest draws of the equity loan scheme is that equity loans are interest-free for the first five years.
If you're able to pay back your equity loan in full by the time these five years are up, you will not have paid a PENNY in interest for it.
However if you don't repay your equity loan by that point then you'll start being charged interest on it (remember this is separate to interest charged on your mortgage). In brief, here's how it works:
- Interest kicks in on the fifth anniversary of your equity loan (ie, from year six).
- The initial rate starts at 1.75%.
- This increases each year by the Retail Prices Index (RPI) measure of inflation, plus 1%, until the loan is paid off.
Let's imagine that the RPI rate plus 1% equals 6%. If the interest rate in year six was 1.75%, then based on the 6% increase your equity loan interest rate for year seven would be 1.86%. So that's 1.75% divided by 100 and multiplied by six, which equals 0.105 (let's say it's 0.11). Add 0.11 to 1.75 to get 1.86%.
So if you bought a home for £200,000 with an equity loan of £40,000, this is how your interest repayments could look (including the £1 monthly management fee you'll have to pay from the start until the interest kicks in):
1-5 N/A 0% £12 6 N/A 1.75% £700 7 6% 1.86% £744 8 6% 1.97% £788 9 6% 2.08% £832 10 6% 2.21% £840
You will only ever pay interest on the original loan amount. So let's say you borrow £40,000 on a £200,000 property...
If property prices rise and your home is now worth £250,000, you'll owe £50,000 as 20% of the property's value, BUT interest will still only be charged on the original £40,000.
Over the years, repayments could become very expensive – particularly as inflation rises. And if you've taken the maximum loan, you could face chunky interest charges.
For example, if you took the maximum £120,000 equity loan in 2013, you'd pay back £2,112 over the first year of paying interest alone – that's £176 in interest a month. And someone with a maximum equity loan in London would have to pay twice that amount – totalling £351 a month.
Struggling with interest repayments?
If paying these is going to be a struggle, you can contact scheme administrators Target on 0345 848 0235 (or at MyFirstHome).
It's vital you speak to it if you're falling behind with payments. This is because an equity loan is just like any other mortgage debt – a financial charge on your home – meaning if you fail to keep up with repayments you could end up seeing your home repossessed.
Interest payments could become even more expensive depending on which day of the year your home is purchased.
MSE research has shown that the cheapest months to use Help to Buy are between January and March, with December being the most expensive. This bizarre quirk could end up costing some homeowners thousands over the life of a mortgage.
You'll still need to get a mortgage for the amount not covered by your deposit or the equity loan
If you're applying for an equity loan you'll still need to be accepted for a mortgage. The mortgage deal you apply for should be cheaper than normal though. That's because:
- The mortgage amount you're borrowing will be smaller (meaning interest being charged on a smaller sum).
- The interest rate you'll be charged will also be better, as rates generally get cheaper the smaller your mortgage.
Typically mortgages get cheaper at 90%, 80%, 75% and 60% loan-to-value (LTV). If you've got a 5% deposit and a 20% equity loan you'll only need to apply for a 75% mortgage, which'll have a cheaper rate than a 95% mortgage.
It's worth noting though that even if your LTV is smaller because you've taken out an equity loan you still might not get access to a mortgage lender's most competitive rates at that LTV band. That's because some lenders charge a small premium for mortgages where an equity loan is being used.
The difference is normally quite small, so it shouldn't feel too penalising. For instance, Barclays offers a two-year fix at 75% LTV for 1.70%, but if you're using an equity loan you'll pay 1.84%. On a £150,000 mortgage, 1.70% is equal to £614 a month (capital and interest repayment), while 1.84% is £10 more a month at £624.
Similar schemes are available in Scotland and Wales
A Help to Buy scheme also exists in Wales. Its structure is similar to the scheme in England, the main difference being that you can only purchase a property worth up to £300,000. The loan is also interest-free for the first five years. For more information, see the Welsh Government website.
Scotland also has a Help to Buy scheme (known as the Affordable New Build Scheme) available on new-build properties worth up to £200,000.
The Scottish Government provides a loan worth up to 15% of a property's value while you provide a 5% deposit, meaning that a mortgage for 80% of the property's value is required. The loan is interest-free for the ENTIRE duration of the term.
Unfortunately there's no Help to Buy scheme in Northern Ireland, but there are other options available for those struggling to get together a deposit.
For some people, using an equity loan is the only option to get on to the housing ladder.
However the use of an equity loan adds another layer of complexity to what is already a complicated process when it comes to home-buying...
Here are a few important things to bear in mind before you decide to take out an equity loan:
Equity loans can jump in cost after five years
One of the draws of the equity loan – as discussed above – is that it can make homeowning more affordable for the first five years.
It's important to remember though that interest on the equity loan kicks in after five years, with the rate increasing each year UNTIL you repay the equity loan in full. This interest can add £100s or even £1,000s onto your yearly costs.
Plus at some point you will need to repay the equity loan.
The Government owns a stake in your home, meaning you'll keep less of any price rise profit
When you take out an equity loan, the Government then owns a stake in your home. If your equity loan is equivalent to 20% of the value of your property, the Government essentially owns 20% of your home until you repay the loan.
And whatever percentage the Government lends you through the equity loan scheme, it will be owed that same percentage when the equity loan is repaid – EVEN if your property has increased in value. For example...
Let's say the Government lent you £40,000 (20%) to buy a £200,000 property in 2019. You pay back the loan in 2029, but your home is now worth £250,000. You would now owe the Government £50,000, as that is 20% of £250,000 – a £10,000 jump in what you initially borrowed.
If your home has increased in value then by the time you repay the equity loan you'll have to pay back more than you borrowed. You'll still benefit from your property increasing in value, but what you owe the Government will also increase correspondingly.
Theoretically if your home depreciates in value then the cost of your loan will also decrease. However decreasing property prices can mean other issues, such as negative equity.
Equity loan versus normal mortgage – which wins?
Unfortunately there is no definitive answer to the question of whether using an equity loan is better than just going with a normal mortgage.
However, what we can show you is roughly how much you'll need to pay in INTEREST over 25 years depending on whether you're using an equity loan or not.
Below we've compared two scenarios. In the first, we've imagined buying a £200,000 property with a 5% deposit of £10,000. We've compared a 95% mortgage (£190,000) to a 75% mortgage (£150,000) with a 20% equity loan (£40,000). In the second scenario, we've also imagined buying a £200,000 property, but this time with a 10% deposit of £20,000. Here we've compared a 90% mortgage (£180,000) to a 75% mortgage with a 15% equity loan (£30,000).
In both scenarios, we've calculated the total interest paid after five,10, 15 and 25 years. We assume that the equity loan is not repaid until 25 years, therefore where an equity loan is used, the interest shown is the total of both the mortgage interest and the interest due on your equity loan.
Remember, interest becomes due on your equity loan after five years, and begins at 1.75%. It increases each year after that - in this instance we're estimating that interest will increase by 6% annually, so from 1.75% in year six to 1.86% in year seven, then to 1.97% and so on.
75% mortgage and 20% equity loan
75% mortgage and 15% equity loan
Interest after 5yrs £9,993 £4,564 £9,022 £4,564 Interest after 10yrs £15,240 £11,876 £13,873 £10,933 Interest after 15 years £18,260 £19,446 £16,514 £17,186 Interest after 25 years £21,180 £38,147 £19,315 £31,770 (1) Assumes 25yr mortgage term and uses mortgage rates found in August 2020.
What the above clearly shows is that an equity loan can work out significantly cheaper in the first five years than a high LTV mortgage.
However, it's clear that from year six – when interest becomes due on the equity loan – the advantage of an equity loan over a normal mortgage narrows. And by the time 25 years is up, the equity loan could have ended up costing you substantially more in interest than a high LTV mortgage.
Ultimately, the longer you hold onto your equity loan, the more it'll end up costing you in interest. The next chapter discusses how you can actually pay the equity loan off.
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How you can pay back the equity loan
While interest becomes payable on the equity loan after five years, the loan itself doesn't have to be repaid until you sell up OR you reach the end of your mortgage term (specified as after 25 years).
If you want to pay off the loan sooner, this can be done in one lump sum or in parts, something known as 'staircasing'. The minimum payment must be equivalent to 10% of your home's value.
So if you're reaching the end of your interest-free period, here are three possible options:
Remortgage and partially (or fully) repay the equity loan
You could remortgage your current mortgage (the traditional mortgage you took out alongside the equity loan) – this is one of the most popular options. This could be done in two different ways...
- Remortgage your standard mortgage and keep the equity loan separate.
- Remortgage to wipe out some or all of the equity loan, meaning you'll likely end up with a bigger standard mortgage.
Whether or not remortgaging is the best option for you will depend on factors such as these:
- Payments will need to be manageable: Don't stretch yourself with a massive mortgage unless it's affordable.
- Are you currently within your mortgage term? If you leave a fixed or 'tracker' mortgage period early, you could face big penalties. Read our Should you remortgage? guide for more info.
If you decide to remortgage and partially or fully repay your equity loan, you'll have to pay an admin fee of £115 or £200 respectively to the administrators of the Help to Buy Equity Loan scheme. More information on this can be found on the MyFirstHome website.
As you can see, this is complex, so it's worth speaking to a mortgage broker to discuss the options available to you. Our Cheap Mortgage Finding guide lists some of the top brokers around.
This all depends on what remortgaging option you're going for. If you're remortgaging your standard mortgage to include the equity loan, you'll have a good choice of lenders to choose from.
But if you're just remortgaging your standard mortgage and keeping the equity loan separate, some lenders won't lend to you (the ones more likely to offer a mortgage here include Halifax, Barclays, Newcastle Building Society, Skipton Building Society and Leeds Building Society).
Even if you can get a mortgage from a lender, you'll have to meet its affordability tests before being approved.
The interest rate you'll pay for the equity loan will be 1.75% in the first year you'll have to pay it back, meaning only the best mortgage deals will beat that.
On the flipside, clearing the equity loan sooner rather than later could be worth it if you think property prices are likely to go up a lot in future. This is because if your home is worth less, you'll pay less to the Government, as it'll take the same percentage of the sale price as you opted for when you took out your equity loan. If the price of your home goes up later, that percentage will also rise.
Whatever you decide, always make sure you do your sums before taking the plunge.
Stay put and pay off the interest or the loan
Another option is simply to stay put and start paying the interest or to see if you can get enough money together to pay off the equity loan. The latter is worth doing if you can afford it, as you'll avoid interest charges – and get full ownership of your property. Otherwise, the Government takes a slice on sale.
You don't have to pay off the whole lot in one go. But rules mean you have to repay at least 10% of the property's current value – or the whole loan amount.
Whether paying off the loan in part or in full, you'll need to have the outstanding loan amount assessed. This must be done by an RICS surveyor – find one here (RICS stands for Royal Institution of Chartered Surveyors). It'll cost about £200 for a valuation, but charges vary.
You'll also pay an admin fee of £200 to pay off the loan (£115 if staircasing). That's on top of any other fees you face. A list of charges is available via MyFirstHome.
Sell and move elsewhere
A final option is to sell up, particularly if the property's price has soared – and bank any profits after the loan is repaid from the sale proceeds. This way you'll avoid paying any interest on the equity loan and you might want to take the next step on the housing ladder, or you might be ready for a change.
Remember, when you sell you'll have to pay back the Government loan in full, worth up to 20% of the sale price (whether your home's value has risen or fallen).
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