Announced in the chancellor’s Autumn Statement was the much-vaunted mortgage indemnity guarantee scheme which is intended to help nearly 100,000 new buyers get onto the property ladder.
Public underwriting of new mortgage debt is not going to be a miracle cure for the mortgage and housing markets on its own, although it may give frustrated, credit-worthy buyers a shot in the arm.
The difficulty lies in the potential side effects of the medicine and despite signing up to the scheme, lenders will have to remain cautious.
The scheme is well intentioned, and may go some way towards alleviating the chronic shortage of housing. In the first three quarters of 2011, just 60,290 new homes were completed in the private sector, according to figures from the Department for Communities and Local Government – the lowest for more than 20 years.
In contrast, the UK’s need for accommodation is still rising, with the population set to hit 70 million by 2027. By encouraging new home sales and therefore financing further new starts, the scheme could stimulate the house building industry if developers use it in the spirit of goodwill in which it is intended.
But the impact of the scheme is difficult to predict and the devil will really be in the detail. Providing a large enough deposit is the biggest challenge facing first-time buyers, but it is by no means the only obstacle.
Lending criteria have remained tight since the credit crunch, with banks and building societies taking a cautious approach to income multiples and the credit history of potential borrowers.
For a scheme to be successful, it is crucial that lenders have confidence in the valuation process
As part of the scheme, lenders will still determine a mortgage application’s success. Given that the mortgages will still be a reasonably high LTV and available only for new-build properties, it is unlikely lenders will significantly ease their criteria.
In fact, with the ongoing exposure of banks to devalued new flats, many still restrict LTVs on these types of properties and the scope of the scheme will be determined by how cautious lenders are towards new lending on this specific form of new-build.
For the scheme to be successful, it is crucial that lenders have confidence in the valuation process. In the past, many builders offered financial incentives to buyers without lenders knowing and cashback schemes could often mean a deposit was in fact provided by a developer, artificially increasing the nominal price of the property being mortgaged and consequently the LTV.
There are already strict guidelines on identifying incentives when valuing new-build properties. For instance, in the Royal Institution of Chartered Surveyors’ Red Book on valuation standards, a specific section was added to ensure valuers gain disclosure of financial incentives when they are valuing in a new development.
Since this addition was supported by the Council of Mortgage Lenders and the process has become transparent, many lenders have become more positive about lending on new-build.
Nevertheless, it’s crucial that borrowers in the scheme aren’t offered additional financial incentives, even if they are disclosed, as prices could be skewed and lenders may find themselves exposed once again if prices fall.
The main concern for lenders is that if the scheme is successful in unlocking first-time buyer demand for new-builds, it will inflate the properties’ price at the time of the first purchase, before it immediately devalues once occupied.
A premium has often been attached to the value of any newly-constructed property. Some buyers only want to live in a home that hasn’t previously been occupied and are willing to pay extra to achieve it.
As a result, the average premium for the purchase has been as high as 15% in the past. This premium has dropped in the last year, so much so that Nationwide is now once again valuing new-build properties ’as new’ rather than on a resale value basis only.
However, the government’s scheme is likely to exacerbate any remaining premiums, creating a bubble in the value of new-build properties.
There is a fear that the developers will factor in their 3.5% per sale contribution to the indemnity fund in their pricing, artificially inflating prices beyond their market level.
In this respect, it’s crucial that developers use the scheme in the spirit it was intended, to benefit customers and make home ownership more affordable for many.
Secondly, if the scheme sees widespread pick-up, given the lack of new homes being built, the demand from buyers will push up prices. But since second-hand homes are not eligible, any subsequent purchaser of the property will not get the benefit of the scheme.
In effect, this would undermine demand for second-hand new homes, and lenders and buyers may find the property immediately depreciate in value after its first purchase.
In a market where property values are not climbing outside London, this could instantly place new borrowers into negative equity and unable to move.
As a result of the potential risk, we could once more see banks and building societies shift towards a more conservative second-hand resale valuation at the outset of the mortgage, rather than an initial new-build valuation.
But with the perceived risk of new-build, there will certainly be a greater onus on valuation providers to demonstrate robust and sensible procedures.
Lenders need to know that the valuations firms they appoint will follow the guidelines on valuing new-builds closely, comparing the value of a property in one development to those in nearby schemes, for instance, to avoid a repeat of the over-valuations that preceded the housing market downturn.
While the MIG scheme can’t provide a miraculous remedy for the economic challenges facing the UK and holding back the mortgage market, it should boost credit-worthy first-time buyers.
But lenders and prospective buyers need to be aware that the medicine is not risk-free and could create a whole new set of problems.