The Help to Buy: Equity Loan scheme was introduced by the government in 2013 to help aspiring homeowners struggling to raise a sufficient deposit get on the property ladder. In the midst of rising house prices, the scheme has become extremely popular, with the number of loans hitting a new all-time high in the financial year 2020/2021.
If you are currently using the scheme or if you are planning to apply, one thing you may be wondering is when it’s best to pay off the loan. Here’s what I think.
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How does the Help to Buy: Equity Loan scheme work?
Before we get into when I think is best to pay off a Help to Buy Loan, let’s go over the basics of how it works.
With this scheme, buyers get an equity loan of up to 20% (or 40% if in London) of the purchase price of a property. You must provide a deposit of at least 5% and get a mortgage for the rest.
There is no interest on the equity loan for the first five years. You will only have to pay a monthly management fee of £1. However, in the sixth year, the loan will incur interest at a rate of 1.75% of the loan’s value. Thereafter, the interest increases every year in April by adding the Consumer Price Index plus 2%.
The current version of the scheme is available to first-time buyers only, and it can only be used to purchase a new build property up to the value of £600,000.
Should you delay paying off your Help to Buy loan?
Given that the loan is interest-free for the first five years, it may be tempting to postpone repaying the loan until the very end of the interest-free period, even if your finances allow you to do so sooner.
However, in my opinion, that is a dangerous path to take. For one, you don’t know what your financial position might be in five years’ time. Your money obligations may change, making repayment of the loan more difficult.
If you are unable to pay off the loan before the end of the interest-free period, the interest rate may quickly rise, making the loan quite expensive, possibly even more expensive than your mortgage.
Remember also that the amount you have to pay is not equivalent to what you borrowed. Rather, it’s a percentage of the property’s current value. More specifically, it’s the percentage of the original price that the loan you got represents. So if the value of the property goes up, you will owe more.
For example, if you got a 20% loan to buy a home worth £200,000 and its value rises to £230,000, you won’t have to repay £40,000 (20% of £200,000). Rather, you will pay £46,000 (20% of £230,000).
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So, when is the best time to pay off a Help to Buy loan?
I believe that the best time to pay off your mortgage is as soon as you are in a financial position to do so.
This is especially true if you think the value of your property may go up in the future (which is a very big possibility in the current housing market). Paying off the loan early could help you avoid having to pay a higher amount than you borrowed. Also, if the value of your property goes up, you will benefit fully from this growth in value.
In fact, it always makes sense to pay off your loan as soon as you have the means to do so, regardless of the direction the market is moving.
Even though a fall in your home’s value will reduce the amount you have to pay back, you could still end up in negative equity. This is a situation in which you owe more money than the property is worth. Being in negative equity could make it difficult for you to move homes or remortgage to another lender.
Final word
Not everyone will be able to pay off their Help to Buy loan early, and that is perfectly fine. Legally, you don’t have to repay the loan until you sell the property or at the end of your mortgage term.
You also don’t have to pay off the entire loan in one go. You can make a partial payment. Just note that any partial payment has to be at least 10% of what the home is worth at the time of repayment.
