The routes to homeownership
The process of buying a home can be very exciting. However, it also signals a big change and a completely different level of responsibility. It can also, at times, feel like something that’s completely out of your reach. Those with a clear intention to buy their own homes are finding it harder than ever to move out of the rental market and into the sphere of homeownership.
Whether you’ve owned a home in the past, or you’re a first time buyer, purchasing a property is arguably the biggest investment you’ll ever make, so it’s very important to get it right. There are a number of options potentially open to you if you’re thinking about purchasing a property. But, however you choose to go about it, there’s a lot to think about. Here, we take a look at the various routes to home ownership available, and what’s involved with each one.
Taking out a mortgage
When it comes to buying a home, taking out a mortgage is still a popular way for many to finance the purchase of their property.
A mortgage is where you have a contract in place with a lender, who will provide you with a loan, to help you buy a property. As part of this contract, you’re responsible as the borrower for repaying your lender back for the money they have lent to you through this mortgage product. Your loan is typically spread out across many years, which you'll make repayments towards.
The repayments are usually made up of you paying back the money you borrowed, plus interest that your lender applies. The loan is secured against your home until it has been paid off in full.
It’s important to know that if you miss any payments or don’t pay off the loan and interest in full, then the lender has the right to repossess your home and sell it to cover the amount you owe them. You might get some money back, if there is anything left over, once the lender has taken what they are owed.
The other important thing to remember is that mortgages are ‘secured’ against the property you buy. This means that if you fail to repay the loan, the lender can sell the property and use the proceeds to cover the amount you owe. This is known as repossession.
Mortgage deposits
When applying for a mortgage, it’s usual for the purchaser to put down a deposit, with a lender providing a mortgage for the rest. The bigger your deposit, the less you'll need to borrow and a potentially lower interest rate. In turn, this may lead to lower monthly repayments or a reduced mortgage term. However, some mortgage lenders may accept as little as a 5% deposit.
A note about repossession
As discussed above, if you fail to repay your mortgage, repossession is a course of action open to your lender. However, for most lenders, this is considered as a last resort. If you fall behind on your mortgage payments, it’s possible that your lender may help you to put a plan in place to help you get back on track. Nevertheless, this is just one reason to ensure that you’re in a position to take on a mortgage in the first instance.
If you’re struggling to meet your mortgage repayments, contact your lender to discuss this. There are also a number of charities and helplines (e.g. Shelter) that will offer you advice for free.
Repayment v interest only mortgages
If you’re in the market for a mortgage, one of the first things you’ll need to consider is whether you want to opt for a repayment or interest only mortgage. But, what’s the difference?
Repayment mortgage
If you opt for a repayment mortgage, then the amount of your monthly payment will go towards paying off both the capital, and the interest on the loan. If you continue to make your monthly repayments as required by the lender, throughout the term of your mortgage, you’ll have paid off the debt in its entirety and will own your home in full.
Whilst it’s likely that your monthly payments will be higher if you choose a repayment mortgage, there are a number of upsides. Over the entire course of your mortgage term, you’re likely to pay less interest on the loan amount. In addition, you may find that you have access to more favourable remortgage deals due to the more positive loan to value ratio you build up over time.
Interest Only
An interest only mortgage is exactly that. When you pay your mortgage each month, you’ll only ever be paying towards the interest due on the loan. At the end of the mortgage term, you’ll be required to pay off the capital in order for you to own the property. However, In April 2014, the Financial conduct Authority introduced stringent rules for lenders considering mortgage applications. Lenders must be satisfied that you can afford to pay back the capital on your property. As such, they undertake a thorough exploration of your financial past, present and future to ensure that this is the case. As a result, interest only mortgages are less common than they have previously been.
Given that you’re only paying the interest, your monthly mortgage payments will probably be lower than those of a repayment mortgage. It’s also likely to be the case that the amount of interest you pay adds up to more over the course of the mortgage term.
However, there are upsides. You’ll have the freedom to explore various investment options (which you should do with the help of a professional financial advisor). Depending on the path you choose, it’s possible that you’ll save enough to cover the capital repayment at the end of the mortgage term. If your investments perform well enough, you may even have some left over to spend how you wish!
Which interest rate?
The decisions you’ll have to make about your mortgage when you’re buying a home don't stop at whether to choose repayment or interest only. You’ll also need to consider the type of interest rate you feel best fits your circumstances.
Fixed rate mortgage
A fixed rate mortgage means that the interest rate on your mortgage is ‘fixed’ for a set period of time. This is usually between two and five years but this can vary. Whether interest rates go up or down during that fixed period of time, your mortgage payments will remain the same.
Variable rate mortgage
With this type of mortgage, the amount you pay each month is subject to change. Changes to the amount you pay occur for a number of different reasons, most notably the economy and whether interest rates have gone up or down. For example, if inflation goes up, then it’s likely that your mortgage payments will too. And vice versa.
Ultimately, there are a number of different mortgage types available. It can feel like somewhat of a minefield, particularly for a first time buyer. As with any financial investment, it’s always best to seek professional, independent advice when considering your options. A financial and/or mortgage advisor should be able to give you advice regarding the most suitable one for you and your situation.
Help to Buy Equity Loan
In March 2013, the then Government introduced the Help to Buy scheme. The incentive has been a popular one and has been extended to March 2023, when it will be replaced by a revised and somewhat restricted version. If you’re in the market for a new build property, the scheme could be just the ticket.
Am I eligible?
In order to qualify, you must be looking to buy a new build property worth up to £600,000. In respect of the deposit, you’ll need to find 5% in the first instance and the Government will provide a further 20%. You’ll then need to apply for a mortgage to fund the remaining 75% of the property purchase price.
As with most things mortgage related, there’s a lot to consider that may impact your decision to use the scheme.
The Government's 20% deposit contribution
Whilst a 20% deposit loan is an attractive prospect, be aware that it does need to be paid back. It’s important to know that when you take the loan, you’re agreeing to the Government being entitled to 20% of the value of your property. So, whether your home has increased or decreased in value, the Government is entitled to a 20% share of the property price at the time of sale or at the end of the mortgage term - whichever comes first.
Paying back the loan
A feature of the scheme is that the 20% deposit loan is interest free for the first five years. You’ll start paying interest from year six, but if your property has increased in value, interest is only payable on the original loan amount. If you want to repay some of the loan prior to the mortgage term being up, you can do this without selling your property. However, you can’t pick and choose how much you intend to repay. There are strict rules in place, meaning that you’ll either need to clear the debt entirely or pay back 10% of the property’s current value.
Help to Buy restrictions
As well as the deposit considerations above, there are other things to think about. If you wish to take advantage of the scheme, you can’t own any other properties at the time you purchase your new home. Neither are you permitted to rent out all or any part of your home whilst you’re subject to Help to Buy. In the event that you want to make alterations or extensions to the property, in some circumstances, you’ll need to seek approval from your Help to Buy Agent.
Shared Ownership
This is a scheme designed to help if you’re a first time buyer or don’t currently own your own home. It applies to both newly-built homes and those being resold by the Housing Association. Under the scheme, you’ll be able to purchase between 25 and 75% of the property. You can do this by using any savings you have, or by taking out a mortgage for which you’ll need to have a 5% deposit. You’ll then pay rent, at a reduced rate, on the remainder.
Increasing your share
It’s possible to increase your share in the property over the course of time that you live there. You can do this by purchasing further shares incrementally. In some circumstances, you can even ‘staircase’ your way to 100% ownership of the property. However, each Housing Association will differ in the rules and regulations they use to govern increased ownership. It will also depend upon the terms of your particular lease. It might be that you can only staircase a certain number of times, or that you have to do so in specific amounts. On this basis, you should always seek advice from an independent professional advisor in order to put in place a plan that best meets your financial circumstances.
Am I eligible?
If you live outside of London, you’ll be eligible for Shared Ownership if you earn £80,000 or less per year. That figure increases to £90,000 for London residents. Whilst you don’t need to be a member of a particular profession (e.g. nursing), priority will be given to those in the military.
The schemes are available across the UK. However, they’re run differently in each country so it’s vital that you consult the relevant body if you plan to use the scheme in Northern Ireland, Scotland or Wales.
What are the benefits of Shared ownership?
As a route to owning a home, Shared Ownership has a number of benefits:
- If you need to take out a mortgage, your deposit only needs to be for 5% of your share and not the entirety of the property value.
- The rent you’ll pay to the Housing Association on the remainder of the property is charged at a reduced rate.
- You may find that you can afford to invest in a property in a sought after postcode. This is because many new build developments are required to provide affordable housing as part of their planning permission.
- As you increase your ownership, the rent you pay on the remainder decreases. This can make your monthly payments more manageable.
Be prepared!
Although Shared Ownership has many benefits, it’s important to factor in the costs associated with the scheme. You’ll be required to pay Stamp Duty, although in some circumstances this can be deferred until you own 80% of the property. Shared Ownership properties are always leasehold. This means that there will be monthly service charges that you’ll be required to pay, this is in addition to the general costs associated with moving, such as removals and solicitors fees.
The Lifetime ISA
Those looking to save for their first property were initially helped by the Help to Buy ISA. This has now been replaced by the Lifetime ISA. The ISA is open to anyone aged between 18 and 39. It’s tax free, and for every £4 that you save, the Government will give you £1. This means that you can potentially save up to a maximum of £4,000 each year.
You have the right to withdraw your money, or some of it, after 12 months. However, the purpose of the withdrawal must be to buy a property up to the value of £450,000. Take note though, you can’t use the proceeds of your Lifetime ISA towards a buy to let property.
Right To Buy
The Right to Buy mortgage scheme has been around in the UK for some time. It was introduced via the Housing Act in 1980 and its purpose has always been to help council tenants buy their council properties at a discount. That discount is significant, with the maximum available being £82,800 outside of London.
What are the eligibility criteria?
In order to be eligible, you must meet the following criteria:
- You must have a legal contract with a landlord.
- You must have had a landlord in the public sector for three years. The three years do not have to have been consecutive.
- The property must be your only or main home.
- You must not share any rooms with people who are not within your household.
- A good credit rating is advisable.
The conditions in relation to the Right to Buy Scheme may vary between different councils and Housing Associations across the UK. Therefore it’s important that you seek professional advice to ensure that you are given the correct guidance.
The future of Right to Buy
Plans to extend the Right to Buy scheme to Housing Association tenants have been discussed for some time. A pilot scheme was rolled out in 2016, with a further pilot scheme in the Midlands due to come to an end in 2020. Time will tell if the Government intends to fully roll out Right to Buy for Housing Associations tenants - watch this space.
Rent To Buy
Whimsically referred to as ‘try before you buy’, the Rent to Buy scheme is yet another path to home ownership for those struggling to get their foot on the property ladder. The scheme allows those who qualify, to rent a property at a subsidised rate for a fixed period of time. When that fixed period is up, there’ll be the option to buy the property or sign up to a Shared Ownership scheme. Each local authority is likely to have different rules with regard to who they consider eligible for rent to buy. If this is something you’re considering, you must discuss the requirements with the relevant local government department. As a general rule you’ll need to have a household income of less than £60,000 per year and be a first time buyer.
The rental period
The maximum period of time you can rent a qualifying property is five years, but it’s often less than this. The benefit of agreeing to an extended rental period is the fact you’ll have longer to save up funds to purchase your property. In fact, if you’re seeking a mortgage during your rental period, you’ll often find very favourable rates which makes renting to buy something worth considering.
As always though, with the benefits come the downsides. Rent to buy schemes are few and far between. It may be that Rent to Buy is not an option in the area you wish to live. With this scheme, it’s a question of whether you’d be prepared to compromise on location for the substantial savings you could potentially make.
Bank of mum and dad
With many people finding it increasingly difficult to buy their own home, more and more people are turning to parents and family members for help. Research by Legal & General has shown that the Bank of Mum and Dad is now a major player when it comes to realising property dreams. In fact, they were technically the 11th biggest lender in 2019, having lent their offspring £6.3 billion, an increase of 10% on the previous year.
Gifted deposits and parental loans
It might be that your parents give you the money for your deposit with no expectation of being repaid. This is known as a gifted deposit. It’s important that parents making this offer take full independent legal advice from a solicitor to discuss the implications. They’ll usually be required to confirm in writing that the deposit money is a gift and that they don’t wish to have an interest in the property.
In other circumstances, your parents may agree to lend you the money for a deposit. If this is the case, you must declare the loan to your lender. This could potentially affect your eligibility for a mortgage, so it's important to seek advice in this regard before making any decisions.
Other ways for parents to help
Aside from the above, parents may also choose to:
- Act as a guarantor on your mortgage.
- Buy the property jointly with you.
- Use their savings or equity in an existing property as security against the loan.
Being gifted a property
It might be that at some point in your life, somebody chooses to give you a property. When embarking on their estate planning, parents or other family members may feel that it’s prudent to consider this option, particularly if they’re looking to downsize or simplify their living arrangements.
On the face of it, being gifted a house appears simple. However, quite often, it’s anything but straightforward. There are a number of things to be aware of and deal with before you can sit back and enjoy your generous turn of events.
Inheritance tax
Inheritance is treated differently depending whether you’re inheriting from a parent or from a someone else. There’s a higher allowance for a parent to child relationship. And, because that’s probably the most likely situation, that’s what we’ll talk about here.
For the purpose of inheritance tax, a property that’s given away is a “potentially exempt transfer”. This means that if the value of the property is above the threshold, and the gifting party survives for seven years after making the gift, then there’ll be no requirement for inheritance tax to be paid.
However, should the gifting party die within seven years of the gift being given, then inheritance tax is still payable if the value of the estate meets the threshold. The current inheritance tax threshold in the UK is £325,000 per person.
*The tax treatment of the Wayhome arrangement is dependent on your individual circumstances and may be subject to change in the future. We don’t provide tax advice so you should seek this independently from a qualified professional before investing.
Gift with a reservation of benefit
It might be the case that somebody proposes to sign their property over to you during their lifetime, but intends to remain living there themselves. Whilst it’s true that someone signing their property over to you makes you the legal owner, it doesn’t help if you need somewhere to live immediately or in the near future.
In addition, it’s a common misconception that this course of action will avoid inheritance tax, but this simply isn't the case. This is a situation known as a ‘gift with a reservation of benefit’, meaning that the property will be subject to inheritance tax upon the death of the person who signed it over to you in the first place. Inheritance tax can potentially be avoided if rent is paid to you as the official owner of the property, at the going rate. But a further important consideration here is the fact that you’ll find yourself liable for income tax on the rent that your new ‘tenants’ pay each month.
Receiving a property as a gift is a big deal, as is giving a property away in the first place. It’s essential that both parties fully understand the implications of what’s involved. On this basis, it’s always advisable to seek professional, independent advice before making any decisions.
Inheritance
If a loved one passes away, it's possible that you'll inherit their property. This could be the result of being named as a beneficiary in a will, or because you’re the next of kin and legally the owner in the event of their death. If you inherit a property, there are a number of potential options open to you.
Living in the property
If you’d like to live in the property you inherit, you’ll need to ascertain whether it has a mortgage attached to it. If it does, you’ll need to decide whether you can afford to take on the mortgage payments and whether a lender is willing to approve you for a mortgage in your own right.
Sell the property
It’s always open to you to sell a property that you inherit. However, this is something that may have to happen if you can’t afford any mortgage payments relating to the property. You may also have to sell if the lender refuses your application to take on the mortgage yourself. If there is a mortgage on the property then you may need to figure out if the sales proceeds will cover repaying all the mortgage or whether there is negative equity.
Rent the property
Putting your inheritance on the rental market could be a great way to cover any mortgage payments associated with the property, or simply to earn some extra income. However, you’ll need to ensure that there are no restrictions on you doing so. For example, a restrictive covenant contained in the title deeds. In addition, if you do choose the rental route, be sure to factor in the income tax liability that comes with the monthly rental payments.
Before making any decisions in relation to a property that you inherit, you’ll need to carefully consider what your responsibilities are in respect of it. For example, is there an inheritance tax liability? If there’s a solicitor dealing with the estate, it’s advisable to liaise with them to ensure that any obligations you have are dealt with appropriately.
Build your own dream house
This is not as outlandish as it sounds. There’s something to be said for a house that’s built on your terms, to your taste, and to your budget. Programmes like Grand Designs can make us feel that building your own home is just a pipe dream. But that’s not always the case. If it’s done in the right way, with the right advice and the right amount of planning, building your own home can be an affordable way of owning your home. In some circumstances, when you build your own property, it’s worth outweighs the cost of the construction. In addition, you’ll be able to install a lot of mod cons from the outset. The cost of adapting existing properties could be a lot more expensive.
Self build mortgage
It may be that you can afford to purchase a piece of land outright. However, it might be the case that you need a mortgage in order to help your self-build dreams come true. Some lenders offer a self build mortgage. The price of these products can be higher than with a standard mortgage. You’re also likely to need a more sizeable deposit.
Have a budget!
If you decide to go down this route, it’s absolutely essential that you budget accordingly. You’ll need to factor in a number of potentially ‘hidden’ costs. For example:
- Land.
- Architects fees.
- Planning permission.
- Delays to the build as a result of bad weather.
- The cost of your rent whilst you’re building your dream home.
- Higher mortgage costs.
As you can see, when you're considering buying a home, there are a number of routes to home ownership for you to consider. As always, you'll need to consider which path best suits you and your current and future circumstances.
Whether you choose the traditional route of applying for a mortgage, or acquire your property via an inheritance, you'll need independent and professional advice before embarking on your journey as a fully fledged property owner.
