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Horseradish

Equity Loan is even more of a time-bomb than you thought

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I present two items:

Case grows for revamp of flawed RPI formula (alternatively this non-paywalled similar article)

and

Help to Buy Equity Loan Funding Administration Agreement

You can probably see where I am going with this. The FT makes the convincing argument that the RPI (Retail Price Index) is a crappy measure of inflation, and in fact outpaces real inflation significantly. No less an important body than the Debt Management Office (you know, the one that issues all those billions of treasury bills on behalf of the government) has stated this position publicly. Further, the ONS calls the results of the RPI "implausible" (with respect to underlying prices). Of course, there is the CPI which does a much better job. The index skews clothing particularly badly, and one item is cited as having increased 50% in the CPI vs 400% in the RPI. The ONS know this but are unwilling to act.

Help to Buy Equity Loans are linked to the RPI after 5 years.

Now, picture this future: The housing market gets a serious blow, and many people who took out 40% Equity Loans in London (or even the 20% ones elsewhere) come to the end of their 5 year free money honeymoon. If they can't sell the property or remortgage the equity loan part (say they are in negative equity) then these people are going to end up on a potentially crushing rate for the equity loan portion of their house - not least because in a crash situation inflation is likely to be, er, rather larger than it is at the moment. It's like a bomb strapped to another bomb.

Edited by Horseradish
Forgot to state explicitly that EL uses RPI

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Isn't it the case though that in a negative equity situation they can write off the htb equity loan?

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Good point, but it's not quite like that. Each portion of the property takes a proportional hit - so with the max the owner takes 60% of the downside, and the government 40%. There's still scope in there for the above scenario. But it doesn't have to be negative equity; continuing flat wage growth is going to mean that these people will find it very hard to chuck an extra 40% onto their mortgage - the bank's just not going to swallow the extra risk.

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Indeed, there are mse etc threads about this. Also mortgages for htb loan holders tend to be at high rates too.

And of course houses sold under the htb scheme seem to go at a significant premium to what they would otherwise go for. I think it's more likely too that much of real terms house price falls will be hidden by monetary inflation. So in the long run htb equity loans could be a horrible ball and chain.

I just think that the chance of ruin from taking the htb equity loan coolaid is too great.

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25 minutes ago, Si1 said:

Indeed, there are mse etc threads about this.

All the MSE threads seem to just be about the "hard to remortgage" part, rather than the "RPI is going to be higher than you think" aspect. I think that second part is new; I've not seen the two linked elsewhere.

Edited by Horseradish
grammar

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1 minute ago, Horseradish said:

All the MSE threads seem to just be about the "hard to remortgage" part, rather than the "RPI is going to be higher than you think" aspect. I think that second part is new; I've not seen it linked elsewhere.

I don't think it's that significant YET. At year 6 the htb loaner has to pay 1.75% of the htb loan value as a fee. And this fee increases by RPI inflation every year. So it might be say 1.8% at year 7 and 1.85% at year etc. I suspect mse forum users don't see this as being significant, yet.

However also if nominal house value goes north in years to come with monetary inflation then the value of the htb loan goes up in proportion, so yes it is a double hit.

What I'm confused about further is what if on the intervening years there's a house price crash in nominal terms, do all the htb loans get downvalued with it or not? So far I've seen evidence of this happening when a property has subsequent build quality issues, but what if the wider market takes a dive?

 

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2 minutes ago, Si1 said:

What I'm confused about further is what if on the intervening years there's a house price crash in nominal terms, do all the htb loans get downvalued with it or not? So far I've seen evidence of this happening when a property has subsequent build quality issues, but what if the wider market takes a dive?

 

Perhaps I'm missing your point here, but I think that the fees only relate to the original loan, and any write-down from a house price crash would only be locked-in on a sale event?

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1 minute ago, Horseradish said:

Perhaps I'm missing your point here, but I think that the fees only relate to the original loan, and any write-down from a house price crash would only be locked-in on a sale event?

I'm confused too:

https://www.leaseholdknowledge.com/taxpayers-face-85000-loss-as-homes-england-accepts-leaseholder-can-pay-back-loan-on-flat-blighted-by-grenfell-cladding

 

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I do see how the htb fees from year 6 onwards are calculated on the original htb loan value however. An updated htb loan value is apparently only calculated should you seek to pay it off in full or sell the house.

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1 minute ago, Horseradish said:

I think that's a pretty exceptional case; nobody wants to set a foot wrong when it comes to anything Grenfell.

Interesting perspective, makes sense.

Time will tell heh.

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4 minutes ago, Si1 said:

I do see how the htb fees from year 6 onwards are calculated on the original htb loan value however. An updated htb loan value is apparently only calculated should you seek to pay it off in full or sell the house.

Pretty much all those threads on MSE assumed a roughly-current level of inflation. So if inflation spikes, and RPI spikes well above that due to the fact that it uses this Carli index rather than a straight average, those assumptions are going to do what assumptions often do...

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1 minute ago, Horseradish said:

Pretty much all those threads on MSE assumed a roughly-current level of inflation. So if inflation spikes, and RPI spikes well above that due to the fact that it uses this Carli index rather than a straight average, those assumptions are going to do what assumptions often do...

But it's still only small percentages of another small percentage. It would take a decade or more to really hit people in the pocket. Most people don't think beyond monthly commitments.

I think it could well be very painful but in a boiled frog sense over twenty years. Not in a crashtastic sense. Excuse me murdering the English language there....

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And it further supports my belief that we'll see a super cycle real terms house price bottom in the 2030s after a few more bust and boom cycles in-between.

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22 minutes ago, Si1 said:

But it's still only small percentages of another small percentage. It would take a decade or more to really hit people in the pocket. Most people don't think beyond monthly commitments.

True, and it would be surprising if the RPI was at 10% for a decade. But perhaps with Brexit and a nasty crash you could see a five year period where it was high. Would probably hit those on the bottom end of the scale hardest as they are the most price sensitive. 

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11 hours ago, Horseradish said:

Good point, but it's not quite like that. Each portion of the property takes a proportional hit - so with the max the owner takes 60% of the downside, and the government 40%. There's still scope in there for the above scenario. But it doesn't have to be negative equity; continuing flat wage growth is going to mean that these people will find it very hard to chuck an extra 40% onto their mortgage - the bank's just not going to swallow the extra risk.

That's not true I'm afraid.

If you sell your HTB house at a loss (assuming that your HTB agent approves your sale price) and repay your mortgage, the agent will accept whatever is left and call it even. So a 40% equity loan actually  gives buyers a 40% cushion before they enter negative equity.

 

Quote

If the market value of your property falls below the level at which it was first purchased, you will repay less than the original amount the Agency contributed to the purchase. As long as you have complied with all your obligations in the Help to Buy mortgage deed, you will not be required to provide for any shortfall in the equity loan if you sell when values have fallen.

https://www.helptobuynw.org.uk/help-advice/selling-your-existing-home/

 

Quote

As long as you have complied with all your obligations in the Help to Buy mortgage deed, you will not be required to provide for any shortfall in the equity loan repayment if you sell when values have fallen.

https://www.helptobuy.gov.uk/wp-content/uploads/Help-to-Buy-Buyers-Guide-Feb-2018-FINAL.pdf

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41 minutes ago, kibuc said:

That's not true I'm afraid.

If you sell your HTB house at a loss (assuming that your HTB agent approves your sale price) and repay your mortgage, the agent will accept whatever is left and call it even. So a 40% equity loan actually  gives buyers a 40% cushion before they enter negative equity.

 

https://www.helptobuynw.org.uk/help-advice/selling-your-existing-home/

 

https://www.helptobuy.gov.uk/wp-content/uploads/Help-to-Buy-Buyers-Guide-Feb-2018-FINAL.pdf

But who eats the debt?

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1 hour ago, kibuc said:

That's not true I'm afraid.

If you sell your HTB house at a loss (assuming that your HTB agent approves your sale price) and repay your mortgage, the agent will accept whatever is left and call it even. So a 40% equity loan actually  gives buyers a 40% cushion before they enter negative equity.

 

https://www.helptobuynw.org.uk/help-advice/selling-your-existing-home/

 

https://www.helptobuy.gov.uk/wp-content/uploads/Help-to-Buy-Buyers-Guide-Feb-2018-FINAL.pdf

sounds like i need to negotiate a 40% discount on a new gaff and use help to buy. 

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1 hour ago, kibuc said:

That's not true I'm afraid.

If you sell your HTB house at a loss (assuming that your HTB agent approves your sale price) and repay your mortgage, the agent will accept whatever is left and call it even. So a 40% equity loan actually  gives buyers a 40% cushion before they enter negative equity.

Er... it is true. Your sources are unfortunately a bit ambiguous. They boil down to:

  • "If the market value of your property falls below the level at which it was first purchased, you will repay less"
  • "you will not be required to provide for any shortfall"

However, if you inspect the Equity Loan Agreement legal text, you'll find the following on page 74:

"The amount of the required repayment is equivalent to the value of the property (or the actual sale price if higher) at the date of repayment (whether that value has increased or decreased) multiplied by the Contribution Percentage.

By way of illustration, if the Contribution Percentage is 20%, the Buyer must pay the Agency 20% of the sale price when he or she sells the property. The actual amount to be repaid will therefore increase if the property increases in value but will decrease if the property decreases in value. The Agency, via the Help to Buy Agent, will require a copy of the property valuation before exchange of contracts." (emphasis mine)

Thus it's not a [max] 40% (20% outside London) cushion, but instead operates as I outlined above. The points you quoted are still true - you repay less and are not liable for a shortfall - but it's proportional rather than a cushion as you describe. I'd be very surprised if the government had allowed their debt to be subordinated.

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49 minutes ago, Horseradish said:

it's proportional rather than a cushion as you describe

So if I have a Contribution Percentage of 20% then I effectively face 4/5ths of the Negative Equity (NE)?

Assuming, of course, that someone wanting to "staircase" (buy out the HTB loan) gets valuations that accept that the NE is real. If, when you buy the HTB out, the valuations are all pie in the sky then it is all pretty much academic.

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1 hour ago, Horseradish said:

Er... it is true. Your sources are unfortunately a bit ambiguous. They boil down to:

  • "If the market value of your property falls below the level at which it was first purchased, you will repay less"
  • "you will not be required to provide for any shortfall"

However, if you inspect the Equity Loan Agreement legal text, you'll find the following on page 74:

"The amount of the required repayment is equivalent to the value of the property (or the actual sale price if higher) at the date of repayment (whether that value has increased or decreased) multiplied by the Contribution Percentage.

By way of illustration, if the Contribution Percentage is 20%, the Buyer must pay the Agency 20% of the sale price when he or she sells the property. The actual amount to be repaid will therefore increase if the property increases in value but will decrease if the property decreases in value. The Agency, via the Help to Buy Agent, will require a copy of the property valuation before exchange of contracts." (emphasis mine)

Thus it's not a [max] 40% (20% outside London) cushion, but instead operates as I outlined above. The points you quoted are still true - you repay less and are not liable for a shortfall - but it's proportional rather than a cushion as you describe. I'd be very surprised if the government had allowed their debt to be subordinated.

I've seen a clarification on that which explained that it is, in fact, a non-recourse loan in disguise. If you sell at a loss with agent's blessing and repay your mortgage in full, you're now liable for the remaining 20% or 40% of the sale price. If you can cover it with whatever is left, you're expected to do so but if there's a shortfall then you just repay whatever is left of the proceeding from the sale and you're scot free, as long as you complied with all obligations towards your mortgage provider.

If there's any ambiguity there, and if (when) the crash comes, I'd expect any government to disambiguate it as above, with poor, over-leveraged "homeowners" pissing their pants with joy and the hard-saving, non-gdp-friendly losers picking up the tab.

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Also, if someone has a HTB contribution then in the 6th year, they pay 1.75% interest on that contribution.

After year 6, they pay (RPI adjusted 1.75)% interest on that contribution (assuming constant RPI +1of 6% this is 1.855%)

After year 7, they pay an interest rate that is an RPI adjustment on the year 6 interest rate (assuming constant RPI+1 of 6% this is 1.9663%)

After year 8, they pay an interest rate that is an RPI adjustment on the year 7 interest rate (assuming constant RPI+1 of 6% this is 2.084%)

So it makes sense to staircase the HTB contribution at that point when the interest on the HTB contribution is equal to the interest rate on the mortgage that could be obtained.

Obviously assuming RPI+1 constant at 6% is a gamble, but even if RPI is a constant 14% (RPI+1 is then 15%) the numbers work out:

Y6 - 1.75%

Y7 - 2.0125%

Y8 - 2.3143%

Y9 - 2.6615%

So it is a balancing act as to when the interest rate on the HTB portion starts to cost more than the interest on a mortgage. Assuming the indebted can continue to avoid punitive SVR rates (in which case).

So how that would balance against mortgage rates at that time remains to be seen. But if RPI skyrockets then I imagine mortgage rates will too?

In terms of the relationship between mortgage rates and RPI ... who knows, of course!

 

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  • 302 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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