Desperate measures for desperate times?
As house prices in the UK continue to slip-slide downwards, compounding fears that the multi-year housing boom has run out of gas, the country’s largest mortgage lender, Lloyds Bank, has unveiled a new mortgage schemecalled “Lend a Hand” to help first-time buyers with little or no personal savings inject fresh blood into the souring market. It is an adjustable-rate mortgage with no down-payment and with a teaser-interest rate for the first three years of just 2.99%. It allows buyers in England and Wales to borrow the entire amount of the purchase price of up to £500,000 ($653,000).
These types of mortgages are high-risk instruments that helped fuel madcap property booms and busts, including bank collapses, in countries like Spain and the UK.
But this one comes with a parental twist. For customers to qualify, they must have a family member (or members) willing and able to place 10% of the loan in a Lloyds savings account for three years as security, where it will accrue 2.5% interest.
“Although times have changed, children still have a similar ambition to their parents – to own their own home,” said the group’s director Vim Maru. “Lend a Hand helps parents to invest in their children’s future and get the best return on their cash.”
And what happens after the first three years are up?
“We’ll also contact you with details of the mortgage options available,” Lloyds says. So on that day, fasten your seat belt. Because the 2.99% was just a teaser rate. The bank cites this “representative example”:
A mortgage of £130,000 payable over 25 years, initially on a fixed rate for 3 years at 2.99% and then on our variable rate of 4.24% for the remaining 22 years, would require 36 monthly payments of £614.32 followed by 264 monthly payments of £692.03.
So after year three, the mortgage payments in this example jump by nearly 14%. To take this example to a place in London, purchased for £500,000, the monthly payment would jump by £296 ($386) a month.
While the scheme clearly has its attractions, including the parental savings account rate of 2.5% in today’s low-interest rate environment, it’s yet to be seen whether it will be enough to lure first-time buyers and their familial sponsors into a highly uncertain housing market. Under-paid and over-indebted, many young people simply cannot afford to put down even a modest 5% deposit on houses whose prices, after they’re adjusted for inflation, have almost doubled in the last 20 years.
Even after multiple quarters of falling prices the average deposit for first-time buyers in London is a staggering £110,182. It’s for this reason that Lloyds Bank is trying to tap the wealth of the baby boomer generation, but even the so-called “Bank of Mom and Dad” is beginning to run out of funds.
All the while, UK house prices continue to trend downward as rampant unaffordability, Brexit-related uncertainty, stamp duty changes (property transaction taxes), and adjustments to mortgage tax relief continue to take their toll. During the final quarter of 2018, values across the prime regional housing markets slipped by 0.9% from where they were at the start of the year, according to London-based property agent, Savills.
In London, the prices of prime property fell by 3% in 2018. During the same period the number of property transactions in the capital’s upmarket “prime” districts slumped 14% to their lowest point since 2008, according to data compiled by LonRes. Property investors are feeling the pain. London Central Portfolio Property Fund, a closed-end fund focused on small apartments worth less than £1 million in Prime Central London, informed its investorsthat it had to write down the value of its properties by 9.6% over the six-month period ending September 30, 2018.
London may be at the epicenter of the UK’s property downturn, but its reverberations have begun to ripple outwards into the commuter belt and are now affecting nationwide figures. Prices in the suburban and commuter markets around the capital fell by 2.6% and 1.6% in 2018 respectively, according to Savills. Values of other prime properties in the wider south slipped by an average of 1.3%. It was only in Scotland and the Midlands & North that prices rose over the past year, albeit modestly.
It is against this backdrop that Lloyds has decided to launch its “Lend a Hand” mortgage. The scheme is part of a commitment by the bank to lend up to £30 billion to first-time buyers by 2020. The goal is not to stoke a new property boom but rather to keep the current one alive.
While Lloyds is not the first UK lender to dust off the 100% mortgage — Barclays Bank, Yorkshire Building Society, Bank of Ireland and the recently privatized Post Office have all unveiled similar deals in the last 12 months — it is the biggest. More worrisome still, last November, the Building Societies Association (BSA) encouraged lenders to “revisit the case for lending up to 100% loan-to-value ratio mortgages”, arguing that technology could make it easier to determine how risky a borrower is.
According to recent polling by YouGov, many consumers will welcome the return of the high-risk financial instrument with open arms: 48% of respondents said they thought this category of mortgage to be a good idea, compared to 32% who said that it was a bad idea.
Lloyds — and other banks — will be happy to oblige, despite the obvious risks attached. Mortgages for 100% of the purchase price not only help fuel dangerous housing bubbles, they also make them a lot riskier when home prices fall, leaving more and more borrowers with negative equity – where the home is worth less than its mortgage.
At this point, homeowners cannot sell the home unless they put more of their own cash into the deal, which is precisely what most of these homeowners cannot do. That, in turn, sharply increases the likelihood of borrowers defaulting on their loans. And when they default, losses start to cascade through the financial system. And that’s why these 100% mortgages are so risky for banks — and even more so for the taxpayers that end up having to bail them out. By Don Quijones.